The Federal Reserve’s preferred inflation gauge surged to a three-year high in April, adding to growing concern at the central bank and on Wall Street over broadening price pressures.
The Personal Consumption Expenditures Index rose 3.8% in April as the conflict in the Middle East pushed oil prices higher. That was in line with expectations and up from 3.5% in March. Excluding volatile food and energy prices on a so-called “core” basis, PCE was up 3.3%, also in line with expectations, and up a tenth from 3.2% in March. Still, that’s the highest core reading in two and a half years.
Further price pains could be coming.
“Given the pricing dynamics for the month of May, it implies that we have not yet witnessed the peak in either topline or core inflation,” said Joe Brusuelas, chief economist for RSM.
He said the move higher in core inflation, which is the best predictor of longer-run inflation, will prove difficult to reverse in the near term and bring back to anywhere near the 2% target.
New York Fed president John Williams, who is also the vice chair of the FOMC, said Thursday that he thinks inflation will remain elevated over the next few months, closing around 4% with core inflation above 3%. But he said headline inflation will probably peak in the next couple of months. He sees holding rates steady and said “policy is in a good place” to respond to the conflict with Iran.
“Inflation, I would say, is probably the single biggest risk element. It’s the one that worries me the most personally,” Goldman Sachs COO John Waldron said at the Bernstein Strategic Decisions Conference in New York.
The data is in line with Fed officials’ expectations, many of whom have said inflation is moving in the wrong direction and that the risks are shifting from a balance between inflation and deterioration in the job market to a greater concern about rising prices.
Most Fed officials see holding interest rates steady for now, with a growing chorus not ruling out a rate hike if inflation becomes persistent.
Federal Reserve governor Lisa Cook is in that camp. She said in a speech Wednesday that she’s closely watching the risk that companies could embed higher energy costs into the prices they set while workers incorporate them into the wages they negotiate. She noted that she’s “prepared to raise rates” if inflation doesn’t fall in a “timely manner.”
Cook’s comments follow those of Fed governor Chris Waller, who said last Friday that he’s looking to hold rates steady in the near term because he’s become concerned higher oil prices could have a lasting impact on inflation, but can’t rule out rate hikes if inflation doesn’t come back down.
Waller, who for some time was more worried about the job market and was one of the most dovish members of the Fed, supporting rate cuts, now says inflation is his bigger concern. He’s joined four other members on the committee — Boston Fed’s Susan Collins, Dallas Fed’s Lorie Logan, Minneapolis Fed’s Neel Kashkari, and Cleveland Fed’s Beth Hammack — in the desire to change language in the Fed’s policy statement that reflects the next move could be a rate cut or a hike.
Fed Vice Chair Philip Jefferson said Wednesday night he expects inflation to decline later this year as the effects of tariffs and the energy shock wane, but he views risks to the upside around the inflation outlook. He’s also watching whether higher energy prices will start to weigh on consumer spending.
Indeed, higher prices have caused US households to draw down their savings. The new report from the Commerce Department showed the savings rate dropped to 2.6% from 3.2% in April.
“Rising prices are really taking a bite out of consumption, and the decline in the savings rate shows consumers are dipping into savings to make ends meet,” said Ellen Zentner, chief economic strategist for Morgan Stanley Wealth Management.
The 2-year Treasury yield, a leading indicator of the Fed’s interest rate policy, remains around 4% this week, 25 basis points above the upper end of the Fed’s target range of 3.5%-3.75%. The bond market is pricing in higher inflation and the prospect of one rate hike this year.
“Should the war in the Middle East not be wrapped up soon, the Federal Reserve will find it difficult to look through the increase in inflation driven by the supply shock that followed the outbreak of hostilities three months ago,” said Brusuelas.
