The Federal Reserve’s preferred inflation measure slowed and consumer spending flatlined in May, suggesting that the central bank’s monetary tightening efforts are beginning to take a toll on the economy. Data released by the Bureau of Economic Analysis this morning showed the core personal consumption expenditures index – targeted by the Fed – rising 0.3 percent in May from the prior month, up 4.6 percent year-over-year – coming in slightly below consensus estimates for a 4.7-percent print. The so-called “supercore” measure – services inflation excluding housing and energy services – favoured by Jerome Powell rose 0.2 percent month-over-month, rising at the slowest pace since July last year. The overall personal consumption expenditures index was up 3.8 percent from a year ago.

Inflation-adjusted household outlays were little changed on the month, while April’s data – which previously showed an 0.8-percent gain – was revised down to 0.2 percent. Personal income rose 0.4 percent month-over-month as strong employment gains helped support overall wage flows. Incomes were 5.5 percent higher relative to the same month last year, led by a 5.7 percent increase in private sector wages and salaries.

Front-end yields slumped and the greenback inched downward as traders lowered odds on rate hikes beyond July. The two year Treasury yield slipped to 4.88 percent, and equity futures moved upward on the news.

Separately, a preliminary estimate showed the Canadian economy growing 0.4 percent on a month-over-month basis in May, suggesting that underlying momentum remains far stronger than many had expected. Statistics Canada said output was essentially unchanged in April, down from the previous 0.2-percent estimate, as federal workers went on strike.

The Canadian dollar climbed after the data hit the wires as traders increased bets on additional rate hikes from the Bank of Canada. With growth on track to hit a 1.4-percent annualized pace in the second quarter, markets think policymakers are likely to deliver more monetary tightening in the months to come – perhaps as early as July. We’re more cautious – we think a final rate hike, if it comes, should land in September. 

Earlier this morning, core inflation rose by less than expected in the euro area, slightly reducing pressure on the European Central Bank to deliver rate hikes subsequent to July’s widely-expected move. Headline prices were up 5.1 percent year-over-year in June, down from 6.1 percent in the previous month. The core measure – which excludes highly-volatile food and energy costs – climbed 5.4 percent – up from 5.3 percent in May, but better than the 5.5 percent forecast from economists. The euro slipped on the print, but recovered as the session rolled on/and weakened further as North America’s data releases hit.

Later today, the University of Michigan will release its final estimate for June consumer sentiment, and the Bank of Canada will publish its second-quarter Business Outlook Survey, providing insight into how Canadian businesses expect economic conditions to evolve.

After today’s releases, Friday’s US and Canadian jobs reports loom as the next big potential volatility catalysts. Signs of slowing employment gains could weaken the impetus for higher interest rates, but we think inflation prints will continue to take precedence in setting policy direction.

Please note: we will be back in your inboxes on Wednesday, July 5. Have a great long weekend!