Month: June 2024

By Paul Gomme and Peter Rupert

Today’s PCE report was largely foreshadowed by the CPI report two weeks ago. Our measure of trend core PCE inflation fell 0.8 percentage points, from 3.42% to 2.61%, compared to the 0.7 point fall in the corresponding CPI inflation rate. The year-over-year core PCE inflation rate fell a more modest 0.2 percentage points to 2.57%. Meanwhile, the month-over-month rate fell a whopping 2.15 points (compared to 1.6 points for CPI) to 1.0%.

The overall (non-core) PCE inflation rate fell to -0.1% on a month-over-month basis; our trend measure fell 1.2 points to 2.25%; and the year-over-year rate dropped a more modest 0.1 points to 2.56%. These changes are roughly in line with the earlier May CPI inflation numbers.

Policy Outlook

As we have earlier pointed out, our trend measures of inflation see through the volatile monthly inflation rate changes while at the same time responding rapidly to changes in the underlying inflation trend — unlike the annual inflation measures. While the monthly inflation rate for May is a welcome development, it is but a single report for a series known for its volatility; the FOMC is unlikely to respond to a single positive report. On the other hand, assuming that monthly inflation rates continue to come in near the FOMC’s 2% target, it will take many months for the annual inflation rate to similarly reflect this 2% rate. While our trend measure of PCE inflation has moved towards the 2% target, it isn’t there yet. Between now and the FOMC’s July 30-31 meeting is a single CPI report, and a PCE report on July 30. Unless the real side of the economy softens, we do not anticipate a rate cut at the end of July.

The FOMC meeting September 17-18 will have PCE inflation measures for July and August, as well as a CPI release on September 11. Given that CPI changes are typically subsequently realized in the PCE, there may be sufficient positive inflation developments by the September meeting to warrant a cut to the Fed funds rate. The only fly in the ointment is that the Fed takes pains to avoid the perception that it is in any way meddling in U.S. elections, and so may feel constrained to wait until after the presidential election.

By Paul Gomme and Peter Rupert

The CPI was unchanged in May according to the BLS release. By any one of the measures, year over year, 3.25%, monthly annualized, 0.69% or our trend measure, 2.70%, CPI inflation is down. The core CPI (ex food and energy) shows a similar pattern.

Food away from home, used cars and trucks and shelter were items with the largest monthly price increases, 0.4%, 0.6% and 0.4%, respectively. The largest declines came from energy commodities, declining 3.6% and a 3.5% decline for the gasoline component.

What to Expect for PCE inflation

As we have discussed in earlier posts, year-over-year inflation measures evolve sluggishly. The reason for this sluggishness is that the year-over-year inflation rate is the 12-month average of month-over-month inflation rates. So, the change in the year-over-year CPI inflation rate equals the month-over-month inflation rate for the current month (the inflation rate being added to the calculation) less the month-over-month inflation rate from 13 months ago (the inflation rate being dropped from the calculation) — all divided by 12. As a result, even if the month-over-month inflation rates started coming in at, say, 2%, it would take nearly 12 months until the year-over-year inflation rate would reflect this new 2% trend.

Instead, consider our trend inflation measure which places a 1/3 weight on the current month-over-month inflation rate, and a 2/3 weight on last month’s trend inflation. Our trend measure of inflation will, necessarily, respond in a more timely fashion to month-over-month inflation rates. Our trend measure of CPI inflation fell by 0.66 percentage points; core inflation by 1.3 percentage points. Similar declines in PCE inflation would result in PCE inflation around 2%, and core PCE inflation around 2.67%. Alternatively, over long periods of time, CPI inflation runs approximately 0.5 percentage points higher than PCE inflation. Subtracting 0.5 percentage points from the May CPI inflation rates suggests PCE inflation of 2.2% for May, and core PCE inflation of 2.8%.

In other words, we expect good news on the PCE inflation front when the data for May is released in a couple of weeks’ time. That said, FOMC members have indicated that they will hold off on rate cuts until they have seen a few months of such positive developments, meaning inflation as measured by the core PCE deflator trending towards 2%. It remains to be seen whether FOMC members will feel pressure to cut rates given that the European Central Bank and the Bank of Canada have already cut their rates.

The FOMC statement came out on the same day as the CPI report and reiterated their earlier view

The Committee does not expect it will be appropriate to reduce the target range until it has gained greater confidence that inflation is moving sustainably toward 2 percent.

FOMC, June 12

And so they left the target rate unchanged at 5.25-5.5%. The general statement from the FOMC is that the real economy is still humming along, inflation is not yet revealing the hoped for sustainable decline.