US PCE and personal spending numbers open the door wider for a September interest rate cut

Today’s release of the May PCE numbers showed the core PCE deflator rising by just 0.08% over the month, the smallest increase since November 2020 and, on its own, providing the Fed with the room it needs to cut interest rates this year.

The slowdown in prices growth was broad based, with – crucially – the core services figure ex-rents, the key measure for the Fed, rising by only 0.17%, a substantial drop from the average increases seen over Q1 of 0.45%. Core goods PCE fell by -0.2%, continuing the fall in goods prices that is being seen in the various measures of inflation, and bringing the 3-mth annualized rate of growth to 1.1%. The note of caution in today’s report is that a significant drag on May’s core figure stemmed from the portfolio management component, which fell 0.04% in reflection of the weaker stock market prices seen over April. This will reverse, given the recovery in equity prices seen in May, meaning it will provide an upwards boost to the June core PCE number, and likely to be of a similar magnitude to today's fall.

However, that point aside, the inflationary outlook is looking increasingly benign, with all the main drivers of the post-pandemic inflationary surge having now mean-reverted or being in the process of doing so: energy and food costs are now largely flat, supply chains are much more fluid, rents are now rising in line with pre-covid norms while increasing signs of a slowing labour market points to slower wages growth going forward. As such, the outlook for core PCE looks consistent with providing the Fed the room it needs to cut interest rates this year.

Also making the case for an interest rate cut were today’s personal income and spending figures, released alongside the PCE numbers. These showed personal spending rising by just 0.2%in May, a small uptick only on the downwardly revised reading of 0.1% recorded in April. In real terms, spending rose by 0.3%, an improvement on the -0.1% reading for April but largely the result of slowing pricing pressures rather than any pick-up in spending appetite per se. Within the numbers, goods spending rose by 0.6%, boosted by a 1.3% increase in real spending on gasoline. However, gasoline expenditures is a volatile series, meaning it is hard to place much significance on individual monthly numbers.

The real concern, though, is spending on services, which showed growth of just 0.1% for the second month in a row and remains much weaker than the figures seen over Q1. The third reading of the Q1 GDP figures had already flagged the softer pace of consumption in Q1 (revised down from 2.0% to 1.6%) relative to H2 last year (where an average growth rate of 3.2% was seen), and today’s numbers offer yet further evidence that the main engine of US economic growth – domestic consumption – is stalling.

The personal income reading of 0.5% for May at first glance offers some hopes of a consumption recovery, especially so given that it represents the biggest monthly increase in incomes since the start of 2023. However, with accumulating evidence showing the labour market to be softening, it is unlikely that today’s number will be repeated going forward. And even factoring in today’s reading still leaves a 3mth-on-3mth annualized rate of growth of just over 1%. Add into the mix the fact that real income growth this year is running some 50% lower than that seen last year, and that the post-pandemic excess stock of savings has now largely spent, and it becomes very difficult to see consumption picking up any momentum going forward.

Overall, therefore, a set of figures that will be both welcome and worrying for the Fed, but which collectively open the door wider for interest rates to be cut this year. Accordingly, as things stand, we still expect a first cut to be delivered in September.