Key Points

  • Consumer spending rose 0.7% month over month in May, while inflation accelerated to its fastest pace in three years during the same period, according to data released Thursday by the U.S. Bureau of Economic Analysis (BEA).
  • The Personal Consumption Expenditures (PCE) price index rose 0.4% month over month in May and 4.1% year over year, more than double the Federal Reserve's 2% inflation target. Excluding volatile food and energy prices, core PCE rose 3.4% year over year.
  • "If the labor market remains stable, we expect consumers will be able to sustain their current spending patterns," LPL Financial Chief Economist Jeffrey Roach said in a report.

In-Depth Analysis

Personal income and disposable personal income both rose 0.7% month over month in May, matching the pace of consumer spending growth, highlighting the economy's resilience despite weak consumer confidence and inflation running above the Fed's target for more than five consecutive years.

The Atlanta Fed's forecast on Thursday showed U.S. gross domestic product (GDP) in the second quarter could grow by 2.5%, 0.4 percentage points higher than the pace in the first quarter. Roach believes that increased shipments of capital goods in April and May indicate solid business spending, which likely contributed to GDP growth.

"Given the current growth trajectory, the Fed is rightly focused on price stability and will maintain a hawkish stance through the summer," Roach said. He added, "If the Iran crisis persists into around Labor Day, the likelihood of inflation pressures spreading to other categories increases significantly, which would force the Fed to act."

According to the CME Group's FedWatch tool, interest rate futures traders see an 80% probability that the Fed will raise the federal funds rate by at least 25 basis points from its current range of 3.5%-3.75% by the end of 2026. One month ago, traders saw a 68% probability of a rate hike.

Fed Chair Kevin Warsh reiterated policymakers' commitment to bringing inflation down to 2% multiple times at a press conference on June 17. Nevertheless, the median of Fed officials' projections this month shows core PCE at 3.3% by the end of 2026, 2.5% by the end of 2027, and still above the 2% target at 2.1% by the end of 2028.

Consumer spending continues to grow even as consumer confidence remains depressed, well below levels seen before the U.S. and Israel began airstrikes on Iran on February 28. According to the Conference Board, the consumer confidence index fell 0.7 points month over month to 93.1 in May due to rising prices for gasoline and other goods.