Inflation, Spending Data Leave a Cloudy Picture for the Federal Reserve

The May PCE data showed consumer spending fell by the most so far this year. (David Paul Morris/Bloomberg)

The Federal Reserve’s key inflation gauge ran just slightly above expectations in May, clouding the outlook for rate cuts and adding to concerns about tariff-induced price pressures as consumer spending slowed.

The core personal consumption expenditures price index, which strips out food and energy prices, rose 0.2% on the month and 2.7% from a year earlier, the Bureau of Economic Analysis said Friday. That topped FactSet estimates for a 0.1% monthly and 2.6% annual gain.

Headline PCE rose 0.1% on the month and 2.3% year over year, in line with expectations.

The numbers were only a little higher than expected, said Greg Wilensky, head of U.S. fixed income at Janus Henderson.

“We only saw limited flow through from tariffs on the goods side of the equation in May with household appliances and the ‘toy’ category showing some increases,” he wrote in a note on Friday.

But that doesn’t mean tariff-induced inflation won’t show up later this summer. “While we also would have expected to already to be seeing a bit more pass through into the inflation statistics, we still expect these impacts to show up in a more meaningful way in the next few months,” wrote Wilensky.

The underlying data also highlight a more precarious situation among consumers. U.S. consumer spending in May fell by the most so far this year and personal income declined by the most since 2021.

Personal income decreased $109.6 billion, or 0.4% at a monthly rate in May. Disposable personal income decreased by $125 billion, or 0.6%, and personal consumption expenditures fell $29.3 billion, or 0.1%.

The drop in personal income largely reflected a decline in Social Security payments toward more normal levels after they overshot their trend in March and April, according to Sam Tombs at Pantheon Macro. It shouldn’t carry into other months, he said.

But the broad-based decline in consumer spending “has raised concern that policy uncertainties weighing on consumer spending in recent months is beginning to flow through actual spending decisions,” wrote Gary Schlossberg, a market strategist at Wells Fargo Investment Institute, in a note.

Friday’s report likely won’t provide policymakers with the clarity they are seeking as they weigh the timing of the central bank’s next move.

Chair Jerome Powell indicated at the Fed’s policy meeting last week that new inflation readings would help determine whether rate cuts can begin as soon as September. Some Fed officials have even signaled openness to cutting rates this summer.

But while May’s numbers likely mean inflation is still on track toward the bank’s 2% target, they did break a three-month streak of lower year-over-year printouts. They also likely diminish the small hope some dovish Fed watchers had for that July rate cut.

The new data didn’t appear to shift market expectations for rate cuts on Friday morning. The majority of investors are still pricing in two quarter-percentage-point cuts this year, one in September and another in December, according to the CME FedWatch Tool.

Investors, meanwhile, appeared more interested in trade policy than inflation readings on Friday morning. The S&P 500 rose to a record after the U.S. and China said they had agreed on a trade-deal framework.

Write to Nicole Goodkind at nicole.goodkind@barrons.com.