What's up with inflation? Not much: PCE likely to show a small rise in prices despite tariffs.

The upcoming May PCE index, the Federal Reserve's preferred inflation gauge, is forecast to show a modest 0.1% rise (headline and core), keeping the annual rate around 2.5%. This expected tame reading underpins investor confidence in continued market strength and validates expectations for two Fed rate cuts in 2025, with the first widely anticipated in September. Despite some limited internal support for a July cut if inflation surprises lower, Fed Chair Powell remains cautious, anticipating tariff-driven inflation to materialize in the coming months, which could complicate the easing path.

Analysis

The market is positioned for a benign May Personal Consumption Expenditures (PCE) report, with consensus forecasts projecting a modest 0.1% rise for both the headline and core indices. This expected data point, which would hold the annual inflation rate around 2.5%, reinforces the prevailing investor narrative that has sustained the recent market rally and supports expectations for two Federal Reserve rate cuts in 2025. This outlook is further substantiated by the already-published tame CPI and PPI reports for May. However, a significant divergence exists between this market sentiment and the explicit caution from Fed Chair Jerome Powell. He anticipates tariff-related price pressures will materialize in the June and July inflation data and has expressed concerns about the risks of a premature policy pivot that might need to be reversed, potentially damaging the economy. While a minority of Fed governors have indicated openness to a July rate cut should inflation remain muted, the dominant stance from the leadership remains one of vigilance, creating a potential friction point between market expectations and Fed policy in the coming months.

Key Decisions for Investors

• While the expected tame May PCE reading supports near-term bullish sentiment, investors should prepare for heightened volatility around the June and July inflation reports, which Fed Chair Powell has flagged as likely to reflect tariff impacts.
• Monitor upcoming Fed commentary closely for any signs of a broadening consensus towards the dovish stance of Governors Waller and Bowman, as a shift away from Powell's cautious narrative would be a primary catalyst for re-pricing the timing of the first rate cut.
• Given the explicit warnings from the Fed about future inflation risks, it is prudent to assess portfolio sensitivity to higher yields and consider hedging strategies against a potential upside inflation surprise that could challenge the market's current disinflationary consensus.