Federal Reserve’s Key Inflation Gauge Unexpectedly Comes in Hotter
Federal Reserve’s Key Inflation Gauge Unexpectedly Comes in Hotter

By Andrew Moran

The Federal Reserve’s preferred inflation gauge unexpectedly climbed in April, leading to concerns that the U.S. central bank could raise interest rates for the 11th straight month in June.

In April, the annual personal consumption expenditure (PCE) price index rose to 4.4 percent, up from 4.2 percent, according to the Bureau of Economic Analysis (BEA). On a month-over-month basis, the headline PCE price index rose 0.4 percent, up from 0.1 percent in the previous month.

The core PCE, which excludes the volatile food and energy components, edged up to 4.7 percent year-over-year, up from 4.6 percent. This was also above the consensus estimate of 4.6 percent. Core PCE also increased by 0.4 percent from March to April, up from 0.3 percent.

Overall, the BEA noted that this was the first jump in PCE inflation since October, reflecting a boost in consumption of goods (0.8 percent) and services (0.3 percent).

Government data show that prices for goods swelled 2.1 percent, and prices for services surged 5.5 percent. Food prices skyrocketed to 6.9 percent, but energy prices declined to 6.3 percent.

Looking ahead to the May inflation data, the Cleveland Fed Bank’s Inflation Nowcasting model suggests the annual PCE will ease to 3.9 percent, and core PCE will come in at 4.7 percent.

In other BEA data, current-dollar and disposable personal income both rose 0.4 percent last month, up from 0.3 percent in March. Likewise, personal spending soared 0.8 percent, up from 0.1 percent, and higher than the market forecast of 0.4 percent.

With soaring borrowing costs, consumers’ personal interest payments advanced to $448.3 billion in April, up from $444.2 billion in the previous month. The personal savings rate tumbled to 4.1 percent, down from 4.5 percent.

This comes after the BEA reported in its second estimate that PCE and core PCE rose to 4.2 percent and 5 percent in the first quarter, respectively.

The Odds of a Rate Hike Grow

Market observers say this is not what Fed Chair Jerome Powell and monetary policymakers want to see, as it could support the case for another rate hike next month.

Following the two days of inflation data, the futures market is now pricing in a quarter-point rate hike at the June Federal Open Market Committee (FOMC) policy meeting. If the Fed pulls the trigger on a rate hike, the institution will raise the benchmark fed funds rate to a range of 5.25 and 5.50 percent.

Another rate hike would officially be higher than the expected median policy rate of 5.1 percent, according to the Fed’s Survey of Economic Projections (SEP) in March (pdf).

Despite shifting expectations of additional tightening, Preston Caldwell, the senior economist for Morningstar Research Services, thinks the Fed finished its rate hikes in May and could begin cutting later this year.

“Once the Fed wins the war against inflation, it will shift to cutting interest rates in order to get the economy moving again,” he wrote in a research note, adding that the possibility of a recession toward the end of the year is high.

Still, the hotter-than-expected data is “also complicating an already partially-botched Fed hiking cycle,” top economist Mohamed El-Erian posted on Twitter.

Other Economic Data

According to the Census Bureau, new orders for U.S.-manufactured durable goods climbed by 1.1 percent in April, down from the upwardly revised 3.3 percent in March. But durable goods orders came in better than market expectations of negative 1 percent.

Durable goods orders excluding defense tumbled by 0.6 percent last month.

The goods trade deficit surged 17 percent to a six-month high of $96.8 billion. Exports fell 5.5 percent to $163.3 billion as domestic companies shipped fewer consumer goods, industrial supplies, oil, and automobiles. Imports rose 1.8 percent to $260 billion, driven by strengthening demand for new cars and trucks.

Retail inventories excluding automobiles fell 0.1 percent, down from the 0.1 percent boost in March. Wholesale inventories dropped 0.2 percent, slightly better from the 0.3 percent jump in March.

Early second-quarter data suggest that the U.S. economy is holding steady in a climate of rising interest rates, a credit crunch, and stubborn inflation. In addition, the first-quarter gross domestic product (GDP) growth rate was revised higher by the BEA, from 1.1 percent to 1.3 percent.

The financial markets were treading water in pre-market trading following the latest inflation figures, with the leading benchmark indexes up around 0.1 percent. Instead, investors have been mainly focused on the debt ceiling negotiations as the White House and Republicans inch closer to establishing a deal to raise the debt limit.

The U.S. Treasury market was mostly up across the board, with the benchmark 10-year yield adding about 2 basis points to nearly 3.84 percent. The 1-month bill added more than 8 basis points to firm above 5.78 percent.

The U.S. Dollar Index (DXY), a gauge of the greenback against a basket of currencies, took a breather to end the trading week, slipping to 104.00. The index is up close to 1 percent this week.

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