US PCE Inflation Expectations for May: Inflationary Pressure Expected to Rise, When Will the Fed Raise Interest Rates?

Summary of Key Points

The U.S. PCE inflation report for May (the Fed's most closely watched inflation indicator) is about to be released, and the market is highly focused on whether it will change the Fed's recently hawkish policy expectations. The report is likely to show that inflation continues to rise (both year-over-year and month-over-month figures for overall and core PCE are accelerating). The driving forces behind this include the transmission of oil prices, a slowdown in housing inflation, persistent inflation in the services sector, increased costs in financial services, and rising expenses related to AI. At the same time, consumers' purchasing power is being eroded by inflation (income growth cannot keep up with spending).

The Fed has shifted to a hawkish stance in June, and most investment banks have raised their expectations for interest rate hikes (for example, Bank of America predicts three hikes this year). However, some argue that weak consumer demand and falling oil prices could cause the Fed to wait and see.

1. Why is PCE inflation continuing to rise in May? These factors are fueling the trend:

The increase in inflation is not due to a single reason but is being driven by multiple factors:

• Oil prices rose first, then fell, but the May data has not yet reflected this: Oil prices surged in May, directly driving up overall PCE (for example, making gas more expensive). Although oil prices have since dropped, the impact will only be reflected in the data in July. Therefore, it is expected that overall PCE will rise by 0.5% month-over-month and 4.1% year-over-year in May.
• Core inflation (excluding food and energy) is also difficult to reduce: Core PCE is the Fed's preferred indicator of real inflation and is expected to rise by 0.3% month-over-month and 3.4% year-over-year. The reasons include:
• Housing inflation is cooling down more slowly: Previously, falling rents helped suppress inflation, but now the decline in rent rates is less significant, reducing its impact on inflation.
• The services sector continues to see price increases: Prices for aviation, hotels, and leisure services (such as travel) have not decreased because oil prices are being passed through to consumers (for example, airfare has become more expensive).
• Fees in financial services have skyrocketed: When the stock market is performing well, people invest more in financial products, leading to higher fees for financial advice and fund management. This is the main driver of rising core PCE.
• AI is also contributing to inflation: There is a significant increase in demand for AI-related software and cloud services, which are priced higher. Since these digital services account for a larger weight in PCE than CPI, the impact of AI on inflation is more pronounced.

2. Consumers are struggling: Income growth cannot keep up with inflation, so they are barely making ends meet:

The income and spending data for May will reveal consumers' difficulties:

• Slow income growth: Expected to rise by 0.4% month-over-month (the same as in April), which is not keeping pace with inflation.
• Spending seems to have increased, but actual consumption has not: Spending rose by 0.6% month-over-month, but after adjusting for inflation, "actual consumption" has only slightly improved. This means that although people are spending more money, they are not buying as much because prices have gone up.
• Conclusion: Inflation is continuously eroding consumers' purchasing power.

3. The Fed's attitude has changed significantly: From "whether to hike rates" to "when to hike rates"

The Fed's June interest rate meeting will mark a complete shift to a hawkish stance, with clear signals:

• Nearly half of the officials believe that interest rate hikes are necessary in 2026 (as shown by the dot plot).
• The new Chair Powell no longer mentions the possibility of interest rate cuts and prioritizes fighting inflation, being very sensitive to every inflation statistic.
• The market has already started pricing in these changes: Financial markets now expect two interest rate hikes in 2026 (about 40 basis points), which is getting closer to the Fed officials' expectations.

4. Investment banks are divided: Some call for three hikes this year, while others warn against hasty action:

There is a wide range of predictions among investment banks regarding interest rate hikes:

• Aggressive camps (Bank of America, Deutsche Bank):
• Bank of America is the most aggressive, predicting 25 basis point hikes in September, October, and December (a total of 75 basis points for the year), arguing that the Fed is more hawkish than expected.
• Deutsche Bank predicts 25 basis point hikes in September and December (a total of 50 basis points for the year) and also suggests that a hike could occur in July (indicating a hawkish risk) or that no hike may happen due to falling oil prices (indicating a dovish risk).
• Wait-and-see camp: These analysts believe that the Fed will not raise interest rates this year, citing reasons such as weak consumer demand and the possibility of stagflation (economic stagnation combined with high inflation).
• Falling oil prices could help cool down inflation: The recent price increases are mainly due to supply issues in the oil sector (such as geopolitical conflicts), not overheated domestic demand. Raising interest rates would not address these supply problems and could instead suppress the economy; it would be better to wait for oil prices to drop.

5. Why is this report so crucial? Can it change the pace of interest rate hikes?

For the market, the May PCE report serves as a guide to the Fed's next move:

• If inflation exceeds expectations, the Fed may raise rates more quickly (for example, in July).
• If inflation falls short of expectations, it may delay rate hikes or give more weight to the wait-and-see camp's views.

In simple terms, this data will determine whether the Fed will be more hawkish or slightly dovish in the coming months and will also affect the trends in the stock and bond markets.

The core message of this news is that inflation continues to rise, the Fed wants to raise interest rates, and the market and investment banks are debating the timing and frequency of these hikes. For laypeople, this means that "prices in the U.S. are still rising, the central bank may raise rates, and our investments (such as the stock market) could be affected."