US May core PCE growth hits a three-year low as expected, supporting rate cut expectations

According to Zhitong Finance, the measure favored by the Federal Reserve to gauge potential inflation in the United States slowed down in May as expected, supporting the rationale for a rate cut later this year. Excluding volatile food and energy items, the US core PCE price index rose by 0.1% in May, in line with expectations, down from 0.20% previously, marking the smallest increase since November 2023. On a non-rounded basis, the index only rose by 0.08%, the lowest increase since November 2020. The US core PCE price index for May recorded a 2.6% year-on-year increase, the smallest since March 2021.

In May, US consumer spending on goods fell by 0.4%, energy prices dropped by 2.1%, offsetting the impact of a 0.2% rise in service prices and a 0.1% rise in food prices. However, housing prices continued to rise, increasing by 0.4% for the fourth consecutive month. It has been proven that costs related to housing are more challenging than Federal Reserve officials expected, to some extent hindering the Fed from cutting rates as expected this year.

However, the Federal Reserve pays closer attention to service sector inflation excluding housing and energy, which tends to be more sticky. Data shows that this indicator grew by 0.1% from the previous month in May, the smallest increase since October last year. This report provides good news for Fed officials looking to start cutting rates in the coming months. After first-quarter inflation data fell short of expectations, they recently lowered their rate cut expectations for this year.

So far, despite the impact of borrowing costs on certain sectors of the economy, household demand remains resilient. The report shows that adjusted for inflation, service sector spending increased by 0.1% driven by airfare and healthcare. Goods spending increased by 0.6 driven by computer software and automobiles. Adjusted for inflation, real personal consumption expenditure grew by 0.3%, in line with expectations.

Although there are some signs of cooling in the labor market, robust wage growth continues to drive consumer spending. Wages and salaries increased by 0.7%. Adjusted for inflation, real disposable income increased by 0.5%, the largest increase since January 2023, matching April. Nominal income increased by 0.5%, exceeding expectations. The savings rate rose to 3.9%, the highest level since the beginning of the year.

Seema Shah, Chief Global Strategist at Xinan Asset Management, said: "Today's personal consumption expenditure data is not surprising, which is a relief for the Fed. However, the policy path remains uncertain. Further deceleration in inflation, coupled with more evidence of a softening labor market, will pave the way for the first rate cut in September." Meanwhile, several data released on Thursday showed that the Federal Reserve's stance on maintaining higher interest rates for a longer period has led to a slowdown in US economic growth. Data released on Thursday showed that the US government lowered the first-quarter personal consumption expenditure to an annual rate of 1.5%. Additionally, data revealed a decline in durable goods orders and shipments, initial jobless claims indicating a weak job market, and signs of a slowdown in the US housing market - with a decrease in US pending home sales in May, reflecting a decline in the number of home purchases by Americans.

According to Trading Economics' econometric model forecasts, based on a combination of global macro models and analysts' general expectations, it is projected that the year-on-year change rate of the US core PCE price index at the end of this quarter will reach 2.60%. The year-on-year growth rate of core PCE in December is expected to decrease to 2.3%, rather than the 2.8% core PCE growth rate shown in the latest official Federal Reserve forecast data.

The slowdown in the preferred price index by the Federal Reserve provides support for rate cuts. After the release of the US May PCE data, traders increased their bets on a rate cut by the Federal Reserve. According to the CME FedWatch Tool, the market currently expects a probability of around 61% for a rate cut in September (slightly up from 59% before the announcement), with the cumulative probability of two rate cuts this year approaching eighty percent.

Federal Reserve officials have been cautious about the timing and pace of rate cuts, although most believe that a rate cut may occur at some point this year as long as the data remains consistent. In the current situation, the Federal Reserve may cut rates at least once this year, and possibly twice. This week, Atlanta Fed President Bostic stated that he still expects a rate cut this year due to signs of inflation declining. Earlier this month, the Fed's dot plot projected only one rate cut by 2024. However, the forward market reflects market expectations of a 45 basis point rate cut by the Fed in 2024, equivalent to less than two rate cuts, with the first rate cut expected to begin in September.