A Floor to Longer-Term Rates; PCE on Deck

While the Fed remains optimistic the first round of rate cuts could occur by year-end, investors are questioning the Committee’s broader ability to offer policy relief, projecting a relatively elevated neutral rate (or the level of policy assumed to neither stimulate nor slow growth). As Bloomberg News pointed out this morning, the expected five-year forward five-year interest rate, a proxy for longer-term rate rates, has stalled at 3.6%. While down from an earlier peak of 4.5% in October, this is more than 80bps above the Fed’s estimate of 2.75%. This suggests the market is pricing in a notably higher floor for yields,?either as a reflection of changed expectations for Fed policy, more structural factors such as fiscal deficits, or both.?

?

This morning, as of 8:28 a.m. ET, the five-year forward five-year inflation rate is at 3.63%.?

?

On Friday, existing home sales fell 0.7% in May from 4.14M to a 4.11M unit pace, a four-month low. According to the median forecast, existing home sales were expected to decline 1.0% in May. Year-over-year, existing home sales fell 2.8% in May, down from the 1.9% annual decline in April and marking the 34th consecutive month of decline.

?

Due to a fall in sales, the months’ supply of existing homes ticked higher from 3.5 months to 3.7 months, averaging 3.5 months over the past three months. Additionally, from a price standpoint, the median cost of a previously owned home climbed 5.8% in May from a year earlier to $419k, the highest on record.????

?

Bottom Line: Uncertainty surrounding the longer-term level for rates continues to wreak havoc on housing market fundamentals.?The more recent notion, in fact, of higher for longer continues to undermine momentum, driving new construction to the lowest level in four years.

From a policy standpoint, a lack of new supply will?only exacerbate the shortfall relative to consumers’ shelter demands, keeping prices elevated and perpetuating the Fed’s challenge to reinstate price stability. At 5.4%, shelter costs, with a weight of about 15% in the PCE (and 36% in the CPI) pose a significant challenge to driving a faster level of disinflation.?

?

Also, on Friday, the S&P Global U.S. Manufacturing PMI rose from 51.3 to a reading of 51.7 in the preliminary June report, a three-month high. According to the median forecast, the index was expected to decline to a reading of 51.0. The Services PMI, meanwhile, rose from 54.8 to 55.1, the highest reading since April 2022, and the Composite PMI ticked up from 54.5 to 54.6 in the preliminary June report, also the highest reading since April 2022.

?

Finally on Friday, the May Leading Indicators Index declined 0.5%, more than the 0.3% decrease expected and following a 0.6% drop the month prior.

?

This week, the focus returns to inflation with a release of the all-important PCE, the Fed’s preferred measure of inflation. Following more sizable improvement in the CPI and outright deflation in the PPI, investors are hoping for a cooler PCE, potentially resulting in a trifecta of goods news for policy makers. Of course, following several months of head fakes at the start of the year with inflation moving higher, the Fed is less apt than investors to look at one month’s data as an indication of achieving price stability, let alone justification to move forward with rate cuts anytime soon. Furthermore, upside risks remain, particularly on the international front.?

?

Recall, the CPI?was flat (0.0%) in May following a 0.3% gain in April. According to the median forecast, the CPI was expected to increase 0.1%. Year-over-year, consumer prices rose 3.3%, a tenth of a percent point below expectations and down from the 3.4% annual increase in April. Excluding food and energy costs, the core CPI rose 0.2% in May, a tenth of a percentage point less than expected and following a 0.3% increase the month prior. May’s 0.2% rise now marks the second consecutive month of cooling momentum. Year-over-year, the core CPI increased 3.4%, a downtick from the 3.6% annual increase in April and the slowest pace in more than three years.

?

The PPI unexpectedly fell 0.2% in May, the largest monthly decline since October and following a 0.5% increase the month prior. According to the median forecast, the PPI was expected to rise 0.1%. Year-over-year, producer prices rose 2.2% in May, down from the 2.3% gain in April. Excluding food and energy costs, the core PPI was flat (0.0%) following a 0.5% rise in April. According to the median forecast, the core PPI was expected to rise 0.3%. Year-over-year, the core PPI increased 2.3% in May, down from the 2.5% annual gain in April and the smallest annual increase in two months.?

?

On Friday, the PCE is expected to be flat in May following a 0.3% gain the month prior, and potentially increase 2.6% on an annual basis, a tenth of a percentage point lower that the pace reported in April. Excluding food and energy, the core PCE is expected to rise 0.1% in May, following a 0.2% gain the month prior, and potentially increase 2.6% year-over-year, a welcomed decline from the 2.8% annual gain in April.

?

While potentially continuing a downward descent back towards the Feds 2% target, after a bout of accelerated price pressures at the start of the year, the PCE remains above an earlier low of 2.5% in February, while the core has remained steady at 2.8% for the past three months.?

?

Aside from inflation, the economic calendar for this week is robust, beginning today with the Dallas Fed Manufacturing Activity Index. The Dallas Fed Index is expected to rise from -19.4 to -15.0 in June.

?

Tomorrow, the Chicago Fed Index, along with, the FHFA House Price Index, the consumer confidence index from the Conference Board, and the Richmond Fed Manufacturing Index will all be released.

?

Later in the week, on Wednesday, weekly mortgage applications, along with new home sales will be released.

?

On Thursday, weekly jobless claims, along with a highlight for the week – the final Q1 GDP print. GDP was revised down from an initial report of 1.6% gain to a 1.3% increase in the second-round report. In the third and final report, GDP is expected to be revised up to a 1.5% gain. While still signaling an ongoing positive rate of growth, the domestic economy has clearly lost momentum, slowing from 4.9% in Q3 to 3.4% at the year-end to now less than 2%.?

?

Also on Thursday, wholesale inventories, along with the May durable goods orders report, pending home sales, and the Kansas City Fed Manufacturing Index

?

Wrapping up the week on Friday, the May personal income and consumption report, and as mentioned earlier, the PCE – the Fed’s preferred inflation gauge.

?

Personal consumption is expected to rise 0.3% in May and 5.4% on an annual basis, a potential uptick from the 5.3% annual gain in April and on par with a steady rate of 5.2% growth for the last three months. Income, meanwhile, is expected to rise 0.4% in May and 4.6% year-over-year, also a potential uptick – albeit minimal – from the 4.5% annual gain in April.

?

Also, on Friday, the final University of Michigan Consumer Sentiment Index for June will be released. In the preliminary June report, consumer confidence fell for the third consecutive month to a reading of 65.6, the lowest reading since November.

?

Finally, on the Fed-speak front, we will hear from a few officials throughout the week including San Francisco Fed President Mary Daly who will speak later today at 2:00 pm ET, Governor Bowman and Governor Cook, who will speak tomorrow, and Richmond’s President Thomas Barkin who will speak on Friday.

?

-Lindsey Piegza, Ph.D., Chief Economist