Goldilocks scenario for US economy, even if politics is getting in the way

The core PCE report from the US for May was the most anticipated data point of the week so far, and it came inline with expectations. The annual rate moderated to 2.6% from 2.8% in April, and the headline rate also fell back to 2.6%. The monthly headline rate was flat in May, compared to April, the lowest rate of monthly growth since November 2023. This suggests that the deflation trend in the US is intact and the recent increase in price pressure was a blip. While Fed speakers this week have sounded cautious about the outlook for inflation in the US, this report is exactly what they need to see ahead of cutting interest rates.

Service prices once again drove inflation pressures, rising 2.7% YoY in May, which is about the level that service prices have been rising in recent months. The price of durable goods fell 0.4%, while non-durable goods prices rose a touch by 0.1% last month.

The goldilocks US economy

While inflation is moderating in line with expectations, personal income continues to rise, it rose by 0.5% in May, while personal spending rose by 0.2%. Personal income growth continues to grow in a moderate fashion, at the same time as inflation growth is falling back. This suggests a soft landing for the US economy, and it may also support a rate cut from the Fed in the early Autumn.

The immediate market reaction has been positive, and US equity futures are pointing to a higher open later today, US bond yields are also lower, which may help to spur risk sentiment on the last trading day of the first half of the year. Expectations for a September rate cut have also risen to 65% from 60% earlier on Friday, and we could see this continue to grow as the US markets get going later this afternoon.

Nvidia’s stock price is also making gains this morning. This stock has been extremely volatile this week, as we have discussed, so a drop in bond yields could help spur a recovery for the AI darling.

Politics on the back burner for now

Financial markets and traders are focused on the economic data and when the Fed will cut interest rates. In contrast, the media is focused on last night’s debate between Biden and Trump. Whether or not the Democrats can force President Biden to step down and replace him with a new candidate seems unlikely right now. It is worth noting that stock markets tend to do slightly better in the long term under Democratic Presidents, however, we don’t think Biden’s disastrous performance at last night’s debate will have a material impact on markets in the short term. The election is still many months away and a lot could change. Added to this, under Biden the economic performance has been spectacular, but the deficit has surged, so the market may struggle to price in the impact of a reduced chance of a win for the Democrats on the back of last night’s debate performance.