Latest PCE inflation data 'flashing red'. This is what it means for advisors

The latest Personal Consumption Expenditures price index data, released early Thursday, underscores the ongoing challenges that advisors and their clients face around inflation, and makes it harder for the Federal Reserve to lower interest rates.

PCE, which is the Federal Reserve’s preferred gauge of inflation, rose 4.1% year-over-year in May, up from an annual increase of 3.8% in April, according to the Bureau of Economic Analysis. May’s annual rate was in line with expectations from economists surveyed by Dow Jones Newswires and the Wall Street Journal, but the elevated level of inflation is garnering attention. “PCE has been the Fed’s preferred measure of inflation for some time, and this month, it’s flashing red,” said Nic Puckrin, macro analyst and founder of Coin Bureau, in a statement. “At 4.1%, it’s at levels last seen in May 2023, and the newly hawkish Fed isn’t going to brush this off.”

Last week the Federal Reserve kept to its path of keeping its policy rate steady at 3.5% to 3.75% in the central bank’s first meeting with Kevin Warsh as chair. The Fed’s stance around rates has sparked speculation that hikes could be looming on the horizon.

“The issue for the Federal Reserve – and for markets – is that inflation is much too high; well above the 2% target that they are aiming for,” said Chris Zaccarelli, chief investment officer for Northlight Asset Management, in a statement. “As a result, Fed Funds futures are going to continue to predict rate hikes, when less than 6 months ago, most people expected cuts.”

However, Coin Bureau’s Puckrin thinks that we could still see the Fed shift direction. “The one mitigating factor is that today’s number doesn’t reflect the recent drop in oil prices – the key reason inflation has resurfaced,” he said. “If next month’s PCE release is much softer, new Fed chair Kevin Warsh can plausibly argue that inflation really was transitory, allowing the central bank to reverse its hawkish stance.”

From the prior month, PCE rose 0.4% in May, after increasing 0.4% in April, and came in below economists’ forecast of a 0.5% increase.

The Core PCE price index, which excludes food and energy, rose 0.3% in May, in line with expectations, and 3.4% from a year ago, also in line with the forecast from economists surveyed by Dow Jones Newswires and the Wall Street Journal.

Other recent economic data also underscore the inflationary environment that advisors and the Fed have to contend with. Data from the U.S. Bureau of Labor Statistics released earlier this month show that May’s Consumer Price Index increased 4.2% over the last 12 months, up from 3.8% in April, and hitting its highest level in three years.

Northlight Asset Management's Zaccarelli notes that, in the first half of the year, markets were able to overcome the headwinds of higher inflation and higher rate expectations because corporate profits were so strong. "It is going to be difficult to keep climbing higher as long as the Fed is poised to raise rates," he added. "It’s our expectation that inflation will start going lower now that the Strait of Hormuz has reopened and oil prices are coming down, so that may alleviate some of the pressure on the Fed, but next month’s data needs to be lower than what we are seeing today if that is going to be the case."