May PPI Undershoots Expectations, Reinforcing Rate Cut Hopes Ahead of Fed Decision

The U.S. Producer Price Index (PPI) for May came in softer than expected Thursday morning, delivering another dose of inflation relief just one day after a cooler-than-anticipated consumer price index. The data reinforced market conviction that the Federal Reserve could begin cutting interest rates as early as September, with Treasury yields dropping and rate futures fully pricing in two cuts by year-end.

Headline PPI rose 0.1% month-over-month in May, below the 0.2% expected by economists. Year-over-year, final demand prices increased 2.6%, exactly in line with consensus. However, the bigger surprise came from the core PPI figures, which exclude volatile food and energy components. Core PPI advanced just 0.1% month-over-month, half the expected 0.3% increase, and decelerated to a 3.0% annual rate, versus the 3.1% estimate.

Even more telling was the "core" measure — final demand less food, energy, and trade services — which also rose just 0.1% for the month, showing minimal underlying pricing pressure. On a 12-month basis, that gauge now stands at 2.7%, suggesting producer-level inflation has settled into a much tamer trajectory.

The softer pricing data was accompanied by an uptick in jobless claims, indicating some cooling in the labor market. Initial unemployment claims rose above expectations, reinforcing the idea that economic activity may be moderating without collapsing — a key ingredient for a so-called soft landing.

Markets wasted little time in adjusting expectations. Futures tied to the fed funds rate now imply an 80% chance of a rate cut in September and have pulled forward the second cut to October, from December previously. Treasury yields declined sharply following the data, with the 10-year note yield falling 6.7 basis points to 4.35%. Gold prices nudged higher, while the dollar extended recent losses. Equities showed a muted but positive bias in early trading as risk sentiment improved modestly.

Under the hood, the details of the PPI report continued to highlight the disinflationary trend in both goods and services. For final demand services, prices edged up 0.1%, largely driven by a 0.4% increase in trade margins. Notably, machinery and vehicle wholesaling margins surged 2.9%. Gains were also seen in categories like traveler accommodations and apparel retailing, but these were partially offset by a 1.1% decline in airline passenger services and a drop in securities brokerage fees.

On the goods side, prices rose 0.2%, with most of the increase tied to the core component (excluding food and energy). Energy prices were flat on the month, while food prices posted a modest 0.1% uptick. Tobacco products, processed poultry, and gasoline contributed to the gains, though jet fuel prices plunged over 8%, offsetting some of the pressure. Overall, input costs across the board appear to be stabilizing, a welcome sign for companies managing tight margins.

The back-to-back moderation in CPI and PPI will complicate the Fed’s messaging ahead of its policy decision next week. While officials are not expected to move rates at the June 12 meeting, they will update economic projections and the so-called dot plot — which outlines each policymaker’s rate forecast. Prior to this week’s data, the consensus expected the median dot to show just one cut in 2024. That now looks vulnerable to revision, particularly if the Fed wants to avoid tightening financial conditions unnecessarily.

Still, some officials may be cautious. Core PCE — the Fed’s preferred inflation gauge — remains higher than the PPI suggests, and policymakers will be wary of sending a premature signal that inflation is fully contained. But with inflation showing signs of decelerating across multiple measures and the labor market softening, the path to easing has clearly become smoother.

In the near term, all eyes will be on how Chair Jerome Powell navigates this updated backdrop. If he emphasizes patience, the market may push back on October odds. But if he acknowledges the cooling trend and opens the door to flexibility, traders will interpret it as a green light for September action.

In sum, May’s PPI report reinforces the narrative that inflation — particularly at the wholesale level — is not reaccelerating. With back-to-back soft prints on producer and consumer prices, and cracks appearing in the labor market, the Fed now has the cover it needs to begin laying the groundwork for rate cuts. Whether they pull the trigger as soon as September will depend less on politics or rhetoric, and more on whether inflation continues to deflate with as little resistance as it did this week.