PCE Inflation Report Signals Higher Rates, Stronger Dollar, and Liquidity Risks

The PCE report will be the key economic release this week and is expected to show headline PCE inflation rising by 0.5% in May, up from 0.4% in April, while the year-over-year rate is projected to increase to 4.0% from 3.8%. Core PCE is expected to rise by 0.3% in May, up from 0.2% in April, with the annual rate increasing to 3.4% from 3.3%.

One area that deserves closer attention is durable goods inflation, which has quietly reaccelerated this year. Durable goods prices in the PCE report are now rising at roughly 3.4% year over year, with the six-month annualized rate running even hotter. While energy and gasoline prices tend to capture most of the headlines, the rebound in durable goods inflation has become a significant driver of core PCE and will be an important component to watch in this week’s report.

Historically, durable goods prices have acted as a deflationary force within the economy. If that trend has truly shifted on a more permanent basis, it would represent a meaningful change in the inflation backdrop. In that scenario, the Fed’s current policy stance may not be restrictive enough to return inflation to its target.

That could be part of the reason why, despite oil prices falling sharply this week, Fed funds futures have not continued to move higher following the Fed meeting. December 2026 Fed funds futures remain above 4%, suggesting the market is still reluctant to price in a more aggressive easing cycle despite the recent decline in energy prices.

Tighter Fed policy and higher interest rates would be bullish for the dollar, and as a result, the dollar has strengthened considerably this year. With the Dollar Index now breaking above resistance around 100.50, there appears to be scope for further gains in the months ahead.

USD/JPY remains one of the most dangerously positioned currency pairs in the FX market, having now returned to its July 2024 high near 161.60. The key question is whether the pair can continue to move higher.

From a technical perspective, the weekly chart shows very little meaningful resistance above the July 2024 highs. There is some resistance around 164, but beyond that, the next notable levels do not appear until roughly 181 and then above 200. In other words, once USD/JPY breaks through 161.60, the chart becomes remarkably thin.

This is precisely the type of setup that should make Japanese government officials increasingly nervous. The higher the USD/JPY rises, the greater the risk of intervention, particularly given the speed at which the pair could advance once it moves into a zone with limited historical resistance.

Finally, this week, reserve balances fell back below the $3 trillion level, driven by a rise in the Treasury General Account (TGA) to around $950 billion following the June 15 tax date. The Treasury is targeting a TGA balance of about $900 billion by month-end, so reserves are likely to increase somewhat in the days ahead, but not by a meaningful amount.

More importantly, Treasury bill paydowns will total $21.8 billion on Tuesday and $12.1 billion on Thursday. After that, these paydowns will quietly fade away next week, and by the first week of July, we will enter a period of heavy bill issuance.

Liquidity flows are set to shift meaningfully in the second half of the year. Based on the latest QRA documents, net bill issuance totaled $272 billion in the January-to-March quarter. In the April-to-June quarter, there were net paydowns of $128 billion. However, in the July-to-September quarter, net bill issuance is expected to reach $348 billion. That means a significant liquidity drain is set to begin shortly.

Bitcoin rallied during the latest round of bill paydowns, climbing back to its 20-day moving average. However, the issuance schedule for the summer months does not appear favorable for Bitcoin or risk assets more broadly.

Glossary by ChatGPT

Core PCE — The Personal Consumption Expenditures price index excluding food and energy, used to measure underlying inflation trends.

Dollar Index (DXY) — An index measuring the value of the U.S. dollar against a basket of major foreign currencies.

Durable Goods Inflation — Price increases in long-lasting consumer goods such as vehicles, appliances, and electronics.

Fed Funds Futures — Futures contracts that reflect market expectations for future Federal Reserve interest rate policy.

PCE Inflation — The Personal Consumption Expenditures price index, the Federal Reserve’s preferred measure of consumer inflation.

Reserve Balances — Deposits held by commercial banks at the Federal Reserve, often used as a measure of banking system liquidity.

Technical Resistance — A price level where an asset has historically encountered selling pressure that may limit further gains.

Treasury General Account (TGA) — The U.S. Treasury’s primary checking account at the Federal Reserve used for government receipts and expenditures.

Treasury Quarterly Refunding Announcement (QRA) — The Treasury Department’s quarterly update outlining borrowing needs and planned debt issuance.

Treasury Bill Issuance — The sale of short-term U.S. government securities used to finance government operations and manage cash balances.

Disclosure

This report contains independent commentary to be used for informational and educational purposes only. Michael Kramer is a member and investment adviser representative with Mott Capital Management. Mr. Kramer is not affiliated with this company and does not serve on the board of any related company that issued this stock. All opinions and analyses presented by Michael Kramer in this analysis or market report are solely Michael Kramer’s views. Readers should not treat any opinion, viewpoint, or prediction expressed by Michael Kramer as a specific solicitation or recommendation to buy or sell a particular security or follow a particular strategy. Michael Kramer’s analyses are based upon information and independent research that he considers reliable, but neither Michael Kramer nor Mott Capital Management guarantees its completeness or accuracy, and it should not be relied upon as such. Michael Kramer is not under any obligation to update or correct any information presented in his analyses. Mr. Kramer’s statements, guidance, and opinions are subject to change without notice. Past performance is not indicative of future results. Neither Michael Kramer nor Mott Capital Management guarantees any specific outcome or profit. You should be aware of the real risk of loss in following any strategy or investment commentary presented in this analysis. Strategies or investments discussed may fluctuate in price or value. Investments or strategies mentioned in this analysis may not be suitable for you. This material does not consider your particular investment objectives, financial situation, or needs and is not intended as a recommendation appropriate for you. You must make an independent decision regarding investments or strategies in this analysis. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Before acting on information in this analysis, you should consider whether it is suitable for your circumstances and strongly consider seeking advice from your own financial or investment adviser to determine the suitability of any investment.

This Week’s PCE Report Could Reinforce Higher Rates and a Stronger Dollar

Glossary by ChatGPT

Disclosure