US Fed Watch: 'Core PCE Inflation' Likely to Decline... Growing Expectations for September Rate Cut

CPI·PPI Slowdown Expected to Ease Core PCE
Month-on-Month Increase Likely Limited to 0.1~0.15%
Rate Cut Probability: 68% in September, 81% in November

The core Personal Consumption Expenditures (PCE) price index, the inflation indicator most closely watched by the U.S. Federal Reserve (Fed), is expected to have recorded its lowest level in six months last month. Following a slowdown in wholesale prices after retail prices, analysts suggest that sticky inflation has begun to ease. Market expectations are rising that the Fed will start cutting interest rates in September.

According to Bloomberg on the 13th (local time), the core PCE price index for May, scheduled to be released on the 28th, is expected to rise by 0.1?0.15% month-over-month. This would be the lowest level since November last year and significantly below the average monthly increase of 0.32% from January to April this year.

Pantheon Macroeconomics forecasts a 0.11% month-over-month increase in the core PCE price index for May. Capital Economics and Citigroup predict increases of 0.11% and 0.15%, respectively.

The core PCE price index excludes volatile energy and food prices to show the underlying trend in inflation. It is the inflation indicator the Fed pays the most attention to. With both the retail price index, the Consumer Price Index (CPI), and the wholesale price index, the Producer Price Index (PPI), showing a slowdown last month, Wall Street expects the core PCE price index to also decelerate.

According to the U.S. Department of Labor on the same day, the PPI for May fell 0.2% month-over-month, marking the largest decline in seven months since October last year. Last month’s PPI increase not only missed expert forecasts (0.1% increase) but also fell significantly below the previous month’s figure (0.5% increase), reversing into a decline after just one month. Nearly 60% of the PPI decline was due to falling gasoline prices. Prices for diesel fuel, commercial electricity, and aircraft fuel also decreased. As a wholesale price index, the PPI affects the retail price index CPI with a time lag, and this is expected to accelerate the CPI’s slowdown.

The day before, the CPI was also confirmed to have slowed. The May CPI rose 3.3% year-over-year, below both the forecast (3.4%) and the previous month’s figure (3.4%). The core CPI increased 3.4% year-over-year, marking the lowest inflation rate in about three years since April 2021 for two consecutive months. It also fell short of market expectations (3.5%) and the previous month’s figure (3.6%).

With consecutive signals of inflation easing, market expectations for interest rate cuts are growing. According to the Chicago Mercantile Exchange (CME) FedWatch, the federal funds futures market on that day reflected over a 68% chance that the Fed will cut rates by at least 0.25 percentage points at the September FOMC meeting. The probability of a 0.25 percentage point or more cut in November exceeds 81%.

Although the Federal Open Market Committee (FOMC) reduced its forecast for rate cuts this year from three to one in its dot plot the day before, the market believes two cuts are possible. Fed Chair Jerome Powell also stated, "Both forecasts of one or two rate cuts this year are plausible," adding, "We are prepared to respond with monetary policy adjustments if the labor market weakens unexpectedly or inflation slows faster than expected."

Amid expectations of rate cuts, the S&P 500 and Nasdaq indices hit record highs. On the New York Stock Exchange (NYSE) that day, the S&P 500 closed up 0.23% at 5433.74, and the Nasdaq rose 0.34% to 17,667.56, marking the fourth consecutive day of record highs. The Dow Jones Industrial Average fell 0.17% to close at 38,647.1. Treasury yields also declined. The U.S. 2-year Treasury yield, sensitive to monetary policy, dropped 4 basis points (1bp = 0.01 percentage points) from the previous trading day to 4.7%, and the U.S. 10-year Treasury yield, the global benchmark for bond yields, fell 4 basis points to 4.24%.

Ian Shepherdson, chief economist at Pantheon Macroeconomics, said, "Slowing rent increases, declining wage inflation, and retail margin pressure forecasts suggest that the core PCE price index will rise more slowly than the Fed’s expectations this week," adding, "This will lay the groundwork for multiple rate cuts starting with the first in September."

Bill Adams, chief economist at Comerica Bank, expects the Fed to cut rates twice, in September and December, and commented, "Recent data have opened the door wider for the Fed to begin cutting rates in the second half of this year."