Core Inflation Stays Below Fed’s 2% Target

May PCE Report Details

In May, headline PCE inflation was 0.2% monthly. That beat estimates for 0.1% but was below April’s reading of 0.3%. On a yearly basis, PCE was 1.5% which beat estimates for 1.4% but fell from 1.6% in April. The all-important core PCE inflation rate was 0.2% monthly which beat estimates for 0.1% and met April’s reading. On a yearly basis, it was 1.6% which met April’s reading and beat estimates for 1.5%. This was a relatively high reading when you consider the May comp was 1.96%. That’s slightly below this mini cycle’s peak. The Fed won’t need to worry about easier comparisons until January 2020.

Expected Core Inflation

In a surprise to no one, core PCE inflation didn’t hit 2% in May. The Fed is fine to keep rates the same. The main question is if inflation will stay at or below the Fed’s target when it starts cutting rates. The Fed says it is cutting rates because inflation is too low, but in reality, it’s more because of the trade war and economic slowdown. The main reason the Fed will probably cut rates in July instead of June is that the G20 summit is in between them. Increased tariffs could accentuate the slowdown. Low inflation gives the Fed clearance to cut rates. The Fed is always basing policy on where it sees the future economy.

The chart below shows the Oxford Economics’ forecast for core CPI and core PCE inflation. As you can see, Oxford Economics doesn’t see core PCE inflation getting above 2% in the next 6 months and sees core CPI falling towards 2%. Keep in mind, Oxford Economics also sees 3 rate cuts this year and growth slowing in 2019 and 2020. Rate cuts are expected to slow the descent of economic growth rather than reverse it. Cycle changes are a big deal. We are far from seeing enough evidence of a turnaround in global and domestic growth.

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Income & Spending Growth

The personal income portion of this May PCE report was strong. Monthly personal income growth was 0.5% which beat estimates for 0.3% and matched April’s growth rate. It beat the high end of the estimate range which was 0.4%. As you can see from the chart below, yearly real disposable income growth was 2.3%. That’s the 2nd straight week this metric improved. The weak inflation rate helps.

Monthly consumer spending growth was 0.4% which matched estimates. April’s growth was revised up from 0.3% to 0.6%. Real yearly spending growth was 2.7%. The gap between real consumer spending growth and real disposable income growth closed a bit. The savings rate stayed at 6.1% which is just 0.1% above the lowest rate since March 2013.

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Consumer Sentiment Wasn’t Bad?

The Conference Board consumer confidence index was weak, causing some to wonder if tariffs are significantly hurting sentiment. A significant decline would lead to weak retail sales and hurt GDP growth. After the Conference Board’s release, I mentioned that it was further off its peak than the other surveys. On Thursday, the Bloomberg Consumer Comfort index increased and hit an 18.5 year high and on Friday the University of Michigan survey improved from its initial reading as it was far from a disaster. It appears the fear about consumer confidence was overdone.

Let’s start with the Bloomberg Comfort index. It increased 1.8 points to 63.6 in the week of June 23rd. That’s the highest reading since December 2000. Sentiment among Democrats was the highest since 2001. If I had to guess, I’d say Democrats are excited about the Democratic presidential primary. Believing in the president probably won’t affect consumer spending. Even if you go from hating the president to loving the president, you can’t spend money you don’t have. Income growth is far more important. That’s not to say this report is a farce. Real income growth and the gains in the stock market probably helped sentiment.

Besides Democrats, single Americans were the most confidence since 2001 and women, people in the West, and those with a college degree also had 18-year highs in confidence. Finally, the confidence index for people making $50,000 per year or less hit the highest level since 2010 when the index started. That’s the opposite of the Conference Board index. The Conference Board index showed confidence for those making under $15,000 was the lowest since 2016. In that weak Conference Board survey, confidence for those under 35 also cratered as you can see in the chart below.  

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Final June University Of Michigan Reading

The June University of Michigan sentiment index still fell from May as you can see from the chart below. However, the final reading was up from the initial reading. The final reading was 98.2 which is higher than the initial reading of 97.9 but below May’s reading of 100. This makes the decline more palatable. You can see that declines like this have occurred numerous times in the past 4 years without it meaning anything.

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This report was also different from the Conference Board index as its weakness was driven by those in the top 3rd of the income distribution. 45% of consumers mentioned tariffs which was up from 30% last month. Like I mentioned 2 weeks ago when I discussed the initial reading of this report if this many people are bringing up tariffs and sentiment is still relatively high, the trade war might not cause consumer spending to crash.

This report is consistent with real personal consumption expenditures growth of 2.5% which very close to the reading from May I previously reviewed. Current conditions are closer to spending growth than expectations, which is good news because the current index was up 1.9 points to 111.9 and the expectations index fell 4.2 points to 89.3. Interest rates were expected to rise by the fewest people in 6 years. That’s an accurate reflection of the recent decline in treasury yields and the expectations for a Fed rate cut. The good news is the decline in mortgage rates is helping home buying.