US PCE numbers suggest underlying inflation is still heading lower

Today’s April PCE deflator figures have been generally welcomed, as they provide the first real sign that the stronger inflation numbers seen over Q1 were very much “bumps in the road”, as Fed Chair Powell described them, and that the disinflationary forces seen over H2 last year are once again starting to exert themselves. However, this will only matter if the reports seen over the next few months paint a similar picture.

The annual headline and core PCE readings today were both unchanged at 2.7% and 2.8% respectively; the monthly headline rate was similarly unchanged at 0.3%. But key was the core monthly rate, which came in at 0.249%, just enough to fall below the threshold for a 0.2% reading to be printed, and meaning it showed its lowest reading since December last year. Within this figure, core PCE services – very much the key consideration for the Fed – rose 0.27%, a substantial fall from the 0.45% average reading seen over Q1 and only marginally stronger than the average 0.24% increase seen over H2 last year. Although only one month’s worth of data, the picture painted is that inflationary pressures are starting to ease in this key sector of the US economy. Core goods prices rose by only 0.1%, presenting no concerns to the inflationary outlook.

Much of the reason for today’s better numbers is attributable to falling consumption, and further evidence of this slowdown in consumer spending was provided by today’s Personal Spending number, which showed a monthly decline from a downwardly revised 0.7% in March to just 0.2% in April; downwards revisions were also applied to the January and February numbers. The underlying theme here should be no surprise, given the downward revisions made to the Q1 GDP numbers and the soft April retail sales report. Rather, it is the speed with which consumption is losing momentum that is the real story. In real terms spending is looking increasingly fragile, with expenditure on goods falling by 0.5% in April alone, to leave spending in the three months to April now down 1% on an annualized basis compared to the previous three months. And accompanying this decline is evidence that spending on services is also starting to buckle, rising by only 0.1% compared to a 0.2% gain in March. On a three-month annualized basis the picture looks rosier, with services spending rising by 3.7% compared to the previous three months. But this strong performance is largely attributable to the solid number seen in February, which will be dropping out of the calculation next month. Overall, it is very hard to see consumer spending in Q2 matching the 2.0% annualized rate seen in Q1, which itself was significantly lower than the 3.2% average rate seen over H2 last year.

However, today’s numbers will not be enough on their own to see the Fed tilt more strongly in favour of an interest rate cut. If the May and June monthly figures match the April figures then it will leave core PCE still rising at 3.3% on an annualized basis, much too strong for the Fed to consider cutting rates. Further signs of strengthening disinflationary pressures are needed, and in this regard the pace at which the expected slowdown in wages growth takes place will be a key consideration, given the direct read-across this has to consumer spending.

Overall, therefore, today’s numbers should provide the Fed with some reassurance that underlying inflationary pressures remain on a downwards path, leaving open the window for the FOMC to deliver an interest rate cut this year. But they are not sufficient on their own to see this window opened, and the Fed will still need to see further evidence of definitively weakening inflationary pressures before committing to a first cut.