U.S. April PCE Preview: Inflation Spreading Across Multiple Sectors Pushes Up Treasuries, May 28 Data May End Rate Policy Debate

Tradingkey - The U.S. Bureau of Economic Analysis (BEA) will release the April PCE inflation report on May 28, Eastern Time.

Since May, multiple economic data points have confirmed that inflation remains elevated, leading markets to even begin betting that the Federal Reserve will pivot toward interest rate hikes within the year. Consequently, U.S. Treasury yields strengthened, with the 30-year yield surging to 5.2% on May 20, reaching its highest level since 2007.

It should be noted that while CPI is a key inflation indicator for the market, the Federal Reserve focuses more on PCE inflation data. This has been its officially established inflation anchor since 2012, with a long-term policy goal of stabilizing the year-over-year PCE growth rate at 2%.

In its decision-making, the Federal Reserve particularly values core PCE, which excludes food and energy prices, believing it is less volatile and provides a more accurate reflection of the economy's underlying inflation trends.

Inflation spreads to food, airfares, and AI chips across multiple sectors.

Reviewing the performance of the U.S. PCE price index in March, the index recorded its largest monthly gain in nearly three years, serving as another significant signal of a resilient U.S. economy alongside persistently high inflationary pressures.

The PCE price index rose 0.7% month-on-month, the highest monthly growth rate since mid-2022, while the corresponding annualized inflation rate climbed to 3.5%, a significant jump from the previous 2.8%, further deviating from the Federal Reserve's 2% long-term inflation target.

In contrast, the Core PCE price index (excluding food and energy prices) performed relatively moderately. The annual Core PCE rate for March was 3.2%, up slightly from the previous 3.0%, while the monthly rate was 0.3%, down from February's 0.4%.

Overall, core inflationary pressures remain within a manageable range. The clear divergence between Core PCE and Headline PCE trends highlights that this rebound in inflation is significantly driven by energy prices.

However, the risks of this round of inflation should not be underestimated; the market has already front-run the Federal Reserve's "rate hike decision" as Treasury yields surge.

Several economic indicators for April, including CPI, PPI, and the import price index, all exceeded market expectations. While the current inflationary pressure is primarily driven by rising energy prices, the data shows signs of inflation spreading to more sectors.

For example, the increase in food prices expanded significantly in April, likely due to the pass-through of upstream costs like fertilizers to the agricultural sector and rising logistics costs; airfares rose for a second consecutive month, reflecting airlines passing fuel cost pressures to consumers.

Meanwhile, explosive growth in AI-related demand has led to a global supply crunch in memory chips, driving up prices for PCs and related hardware, further exacerbating inflation stickiness. This indicates that price pressures are no longer confined to energy but are spreading to a wider range of goods and services.

PCE Inflation Expectations Revised for the Third Consecutive Time; Fed Interest Rate Policy Enters Wait-and-See Period

This final inflation report released in May will put an end to the Federal Reserve's policy debate over pivoting between rate cuts and hikes. If the data confirms that inflation is accelerating and spreading to more sectors, the Fed may pivot entirely toward a rate-hike stance.

A recent Reuters poll shows that most economists expect the Federal Reserve to remain on hold this year and not cut rates. Although the conflict in Iran has driven up energy prices and inflation, most respondents still believe this oil-driven inflationary pressure is transitory and will not fully spread to other consumer prices.

The survey indicates that the Fed has maintained the federal funds rate in the 3.50%-3.75% range since last December, and nearly 85% of surveyed economists now predict rates will remain unchanged at least until the third quarter of this year. By contrast, over two-thirds of respondents last month expected at least one rate cut this year, reflecting a clear shift in market expectations.

Bank of America stated that the most likely scenario for the Fed is to remain on hold, though both rate hikes and cuts remain possibilities. It pointed out that if the Fed's next move is a rate cut, it is more likely to occur next year rather than this year.

Current market forecasts show that the U.S. PCE price index will see year-over-year increases of 3.9%, 3.7%, and 3.4% in the second, third, and fourth quarters, respectively, an upward revision of approximately 0.25 percentage points from last month. This marks the third consecutive time the market has raised full-year inflation expectations. Despite rising expectations, nearly 86% of respondents still consider the current inflationary pressure to be transitory.

Notably, some economists have warned that with frequent global geopolitical conflicts and supply chain shocks in recent years, similar inflationary shocks may become more normalized in the future.