May's Personal Consumption Expenditures data, released Thursday, showed headline inflation climbing to 4.1% year-over-year and core PCE reaching 3.4%—both at their highest annual readings in roughly three years—while consumer spending, disposable income, and personal income each rose 0.7%. The numbers land directly at the feet of Federal Reserve Chairman Kevin Warsh, whose young chairmanship must now contend with a consumer that refuses to slow and inflation that has broadened beyond an energy shock.
What the Numbers Show
The headline PCE index rose 0.4% in May on a monthly basis. The core measure, which strips out food and energy, climbed 3.4% from a year earlier. On a three-month annualized basis, core PCE eased to 3.5% in May from 4.4% in February—a direction the Fed can point to, but a pace still well above its 2% target. Inflation-adjusted spending also rose from April, and the gains spanned both goods and services, not just categories tied to energy or supply disruptions.
Olu Sonola, economist at Fitch Ratings, was direct: the U.S. consumer is not cracking. He noted that the oil price shock has not derailed household spending and that while headline inflation may be nearing a peak as energy prices fall, the underlying details remain too firm for the Fed to ignore. His conclusion on rates was sharper still: for markets hoping the central bank can hold steady through 2026, the data are moving in the wrong direction.
The Real-Rate Complication
Until Thursday, the Fed could plausibly argue that elevated inflation reflected the Iran war and temporary supply disruptions that would fade on their own. The May data were captured before the ceasefire, the reopening of the Strait of Hormuz, and the subsequent decline in oil prices, giving policymakers some basis for expecting relief ahead. But broad income growth and resilient consumer spending undercut the argument that supply-side forces are the whole story.
A subtler problem compounds the picture. Bank of America noted this week that as inflation rises while nominal policy rates stay unchanged, both realized and forward-looking real interest rates are falling. By standing still, the Fed may effectively be loosening financial conditions rather than holding them firm.
A New Inflation Source Takes Shape
Alongside the consumer data, Apple announced it will raise prices on MacBooks and iPads, citing soaring memory chip costs. Hours earlier, Micron Technology reported another strong quarter and signaled that AI-driven demand for memory continues to outstrip supply, with the shortage potentially persisting. Even as falling oil prices ease one pressure point, AI-related supply constraints are generating new ones—and some companies appear confident enough in their pricing power to pass those costs to consumers.
CME FedWatch data now imply roughly an 80% probability that interest rates will be higher by year-end, a signal that markets are treating a hike as the base case, not a tail risk.