Inflation Eases, Boosting Real Incomes and Consumer Spending: A Fed Rate Cut on the Horizon?
Inflation Eases, Boosting Real Incomes and Consumer Spending: A Fed Rate Cut on the Horizon?
Inflation remains above the Federal Reserve’s target, but it has meaningfully cooled in recent months, providing a boost to real incomes and consumer spending. According to today's Personal Income report, the headline Personal Consumption Expenditures (PCE) Price Index was flat in May, while core PCE inflation, which excludes volatile food and energy prices, increased by just 0.1%. PCE inflation came in even lower than economists had predicted on the basis of the soft Consumer Price Index (CPI) and Producer Price Index (PPI) reports earlier this month.
Key Inflation Trends
Over the past twelve months, total PCE prices have risen by 2.6%, a significant improvement from the 4.0% increase recorded a year ago. Core PCE prices also rose by 2.6%, the lowest reading since March 2021.
Energy prices decreased by 2.1% in May, marking the largest drop since October 2023. Food prices at home increased slightly but have remained mostly stable
The data for core services excluding housing also showed a slowdown, with inflation at 0.1% in May compared to the 0.3% average rate over the prior three months. Housing prices, on the other hand, increased by 0.4%, maintaining the same pace as in the previous three months.
The Effects on Real Incomes and Consumer Spending
Easing inflation has had a positive effect on real incomes and consumer spending. Nominal personal income grew by 0.5% in May, aligning with the average growth rate over the past six months and exceeding the 0.3% increase recorded in April. Aggregate compensation, reflecting both job and pay gains, increased by 0.6% in May, surpassing the average pace from the prior six months. Over the past year, real compensation has risen by 2.4%, driven by strong job growth, rising wages, and easing inflation.
Real disposable personal income, which accounts for taxes and government benefits, also rose by 0.5% in May and by 1.1% over the past year. Since December 2019, after-tax personal income before government transfers has increased by approximately 5% per person in real terms.
Consumer spending, which accounts for roughly 70% of GDP, continues to grow at a healthy pace. In May, nominal consumer spending rose by 0.2%, while real consumer spending increased by 0.3%. Goods consumption rebounded with a 0.6% increase, while services spending remained steady, growing 0.1%.
Prospects of a Fed Rate Cut
The recent cooling of inflation, paired with an uptick in the unemployment rate to 4% in May from a low of 3.4% last April, sets the stage for a potential Federal Reserve rate cut in September. Following today’s PCE report, market odds of a September cut rose to 74%.
A reduction in interest rates would lower borrowing costs for households and businesses, encouraging investments in new homes and business expansion, ultimately boosting employment. A so-called rolling recession in interest rate-sensitive sectors, such as manufacturing and housing, could soon turn into a rolling recovery.
Companies that have been exceedingly cautious for the past two years, conserving cash to shore up their balance sheets following large unrealized losses on their bond portfolios, will be able to emerge from hibernation and pursue long-term strategic investments again. Those will necessarily include investments in developing more robust talent pipelines, as a record number of Americans turn 65, and the economy faces five years of elevated retirements.
