Summary: US core PCE price index up 0.3% in May, less than expected; annual rate slows from 4.9% to 4.7%; still too high for Fed; Treasury yields down; 168bps of Fed rate rises priced in over next 12 months.
One of the US Fed’s favoured measures of inflation is the change in the core personal consumption expenditures (PCE) price index. After hitting the Fed’s target at the time of 2.0% in mid-2018, the annual rate then hovered in a range between 1.8% and 2.0% before it eased back to a range between 1.5% and 1.8% through 2019. It then plummeted below 1.0% in April 2020 before rising back to around 1.5% in the September quarter of that year. It has since increased significantly above the Fed’s target.
The latest figures have now been published by the Bureau of Economic Analysis as part of the May personal income and expenditures report. Core PCE prices rose by 0.3% over the month, less than the 0.5% which had been generally expected but in line with April’s increase. On a 12-month basis, the core PCE inflation rate slowed from April’s figure of 4.9% to 4.7%.
NAB senior economist Tapas Strickland said the annual rate was “still too high for the Fed and unlikely to sway them from their current path.”
US Treasury bond yields fell on the day. By the close of business, the 2-year Treasury bond yield had shed 9bps to 2.97%, the 10-year yield had lost 8bps to 3.02% with the 30-year yield finished 3bps lower at 3.19%.
In terms of US Fed policy, expectations of a higher federal funds rate over the next 12 months softened, particularly with respect to 2023. At the close of business, July contracts implied an effective federal funds rate of 1.67%, 9bps higher than the current spot rate while September contracts implied a rate of 2.425%. June 2023 futures contracts implied 3.26%, 168bps above the spot rate.
The core version of PCE strips out energy and food components, which are volatile from month to month, in an attempt to identify the prevailing trend. It is not the only measure of inflation used by the Fed; the Fed also tracks the Consumer Price Index (CPI) and the Producer Price Index (PPI) from the Department of Labor. However, it is the one measure which is most often referred to in FOMC minutes.