Prices Still Bite

Inflation Keeps the Fed Cornered

This week’s US data gave the Federal Reserve a problem it cannot easily look past. While growth is holding up, consumers are still spending, and inflation is still way too high.

First-quarter Gross Domestic Product (GDP) was revised up to 2.1%, better than the prior 1.6% estimate, though the upgrade was helped by lower imports, likely due to tariffs, rather than a surge in household demand. Consumer spending was revised downward, and private domestic demand looked softer than the headline number suggested.

Inflation Still Has Teeth

The May Personal Consumption Expenditures (PCE) report was harder for the Fed to dismiss. Personal income rose 0.7%, spending rose 0.7%, and real spending still increased after inflation. Consumers are not exactly thriving, but they are still spending enough to keep the economy moving.

Prices are the issue. The PCE price index rose 4.1% from a year earlier, while core PCE rose 3.4%. That keeps inflation well above the Fed’s comfort zone. The worry is that higher fuel costs tied to Iran tensions are no longer just a gas-pump story. They are starting to press into other parts of the checkout line.

Consumers Are Tired

Consumer sentiment improved in June, helped by some early relief in gasoline prices. But the mood is still weak. The University of Michigan’s final sentiment index rose to 49.5 from 44.8 in May, while year-ahead inflation expectations stayed elevated at 4.6%.

Gas prices gave households a bit of breathing room, but the broader squeeze has not gone away. Inflation expectations have cooled slightly, but they are still too high to ignore.

No Easy Off-Ramp

This week’s data gave the Fed little reason to soften its tone. Growth is holding up, consumers are still spending, and inflation remains too firm for policymakers to start laying the groundwork for cuts. Markets have noticed. The CME FedWatch tool now puts the probability of a July rate hike at 29.9%, still below the odds of a hold, but high enough to show that another hike is no longer being treated as a long shot.

That leaves Kevin Warsh with a harder hand than markets wanted. The economy has not weakened enough to force relief, inflation has not cooled enough to dismiss, and consumers are still feeling the squeeze. Unless price pressure fades quickly, the Fed has room to stay hawkish, and less room to write this off as a temporary energy shock.

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