The Federal Reserve's preferred inflation gauge, the personal consumption expenditures (PCE) price index, jumped 0.7% in March, marking the largest gain since June 2022 and exceeding economists' expectations. According to the Commerce Department's Bureau of Economic Analysis, PCE inflation shot up to 3.5% in the 12 months through March, representing the biggest rise since May 2023 and significantly above the Fed's 2% target. The data was included in the advance first-quarter GDP report, with the BEA catching up on key releases following delays caused by last year's government shutdown. Core PCE inflation, excluding volatile food and energy components, advanced 3.2% following a 3.2% increase in February, while the Fed tracks these PCE price measures for its inflation target.
The primary driver of March's inflation acceleration was a dramatic spike in gasoline prices, with the average national retail gasoline price surging 24.1% in March, according to the US Energy Information Administration. Prices at the pump have continued to rise, hitting their highest level in nearly four years this week. The Iran war has significantly boosted financial market expectations that the Federal Reserve could keep interest rates unchanged well into next year, as the conflict has raised gasoline prices substantially. Inflation was already elevated before the war, largely because of President Trump's sweeping import duties, making the recent surge even more pronounced. The most glaring reality is at the pump when filling cars, as it now takes $50 to fill a tank that used to cost $30, reflecting the broader impact of higher oil prices on consumer costs.
Despite the inflationary pressures, consumer spending remained robust in March, with consumer spending surging 0.9% after rising 0.6% in February. However, when adjusted for inflation, spending rose only 0.2% after gaining 0.3%, setting consumption and the overall economy on a slower growth trajectory heading into the second quarter. Economists expect the economic fallout from the war to be more pronounced in the second quarter, as the combination of higher gasoline prices and elevated inflation creates headwinds for consumer spending patterns. Wages are not keeping up with the increased cost of living, raising questions about where the extra money needed to break even will come from.
Kansas City Federal Reserve President Jeffrey Schmid signaled on Thursday that the central bank may need to consider rate hikes as inflation hovers near 3.5%, staying above the Fed's 2% target for years. According to The Economic Times, Schmid posed the central question: "Do we stay patient?" The Fed's choice now appears to be between being patient and holding interest rates steady or hiking rates to tamp down inflation that has been above target for more than five years. The central bank left its benchmark overnight interest rate in the 3.50%-3.75% range on Wednesday citing rising inflation concerns from the conflict, with the latest PCE data reinforcing the need for continued vigilance. However, economists note that 3.5% interest rates are historically very low and yield no real rate of return when inflation is factored in, suggesting the Fed may need to consider more aggressive monetary policy measures.
The Institute of Supply Management (ISM) service index rose to 54.5 in May, up from 53.6 in April, according to Investing.com India. The business activity component increased to 57.7 in May from 55.9 in April, while the new order component rose to 57.3 in May from 53.5 in April. Most notably, the inventories component surged to 62.5 in May from 53.1 in April, signaling substantial order backlogs and strong future demand. 17 of the 18 service industries surveyed by ISM reported expansion in May, up from 14 industries in April.
The employment outlook remains positive following strong private sector hiring data. As reported by Investing.com India, ADP announced that private payrolls rose by 122,000 in May, which was the largest increase in the past 16 months and significantly exceeded economists' consensus estimate of 110,000. Nela Richardson, chief economist at ADP, noted that hiring was more broad-based in May than in recent years and that the labor market continues to show sustained momentum going into the summer hiring season.
