Market Brief: Markets Turn Cautious As US Consumer Spending Engine Slows

The Federal Reserve’s preferred inflation measure came in slightly hotter than expected in May—lending support to the central bank’s cautious approach—but personal spending levels missed forecasts, pointing to a more profound slowdown ahead. Data released by the Bureau of Economic Analysis this morning showed the core personal consumption expenditures index rising 0.2 percent from the prior month, topping market forecasts for a 0.1-percent increase. On a year-over-year basis, core price growth sped up to 2.7 percent, also exceeding economist estimates for a 2.6 percent advance, and the prior month’s increase was revised up to 2.5 percent. The overall personal consumption expenditures index climbed 0.1 percent relative to the prior month, and was up 2.3 percent from a year ago, speeding up from April’s 2.2 percent.

Households suffered a hit to income growth and became more cautious spenders in the month, suggesting that the Trump administration’s economic policies began to impact the growth outlook. Personal income tumbled -0.4 percent month-over-month as government transfers fell, and inflation-adjusted household spending fell -0.1 percent, with both missing forecasts that had been set at 0.3 percent and 0.1 percent, respectively. This followed yesterday’s third revision to the first quarter’s gross domestic product reading, which showed consumer spending growing at the weakest pace since the pandemic, adding to negative trade effects in driving the economy into a downwardly-revised -0.5-percent contraction.

Front-end Treasury yields are slumping and the dollar is retreating as market participants maintain hedges against the still-unlikely possibility of an early summer rate cut and double down on policy easing expectations across the front end of the curve. Odds on a July move are holding near the 20 percent mark, while Fed Funds futures are pointing to 65 basis points in rate cuts by year end, up marginally from 63 just ahead of the release.

Unless there’s a bounceback by Monday, the dollar looks set to end the first half with its worst performance since the Bretton Woods fixed exchange-rate system collapsed in 1973. The DXY dollar index is down 10.4 percent year to date as global investors downgrade expectations for the American economy, worry about the country’s fiscal outlook, and reallocate capital into other jurisdictions. We suspect this has gone a little too far in the short term—rate differentials seem likely to play a more supportive role in the months ahead—but there’s no doubt that the headwinds facing the dollar over the long term have grown substantially stronger, suggesting that once-durable currency trading relationships could remain absent for a prolonged period of time.

Separately, the Canadian economy kept decelerating last month, but avoided the type of extreme growth contraction that might have forced the Bank of Canada to ease policy more aggressively at the end of next month. Numbers released by Statistics Canada this morning showed real gross domestic product shrinking 0.1-percent on a month-over-month basis in April—matching market expectations and the agency’s own preliminary estimate—as tariff increases clobbered activity in the manufacturing sector. An early estimate pointed to a similar level of weakness in May, with declines in mining, quarrying, and oil and gas industries offsetting a modest rise in real estate sector activity.

The Canadian dollar is trading almost unchanged as rate differentials hold firm across the front end of the curve. Odds on a rate cut at the Bank of Canada’s late-July decision are holding around the one-in-three mark, and could swing sharply in the coming weeks as a raft of data releases—including several inflation, labour market, and retail sales readings—prepare the ground for the Bank’s quarterly surveys, which will provide valuable insight into how businesses and consumers are managing amid still-elevated uncertainty levels. We think downside risks to the economy now clearly outweigh upside inflation risks, but nonetheless expect the Bank to stay on hold through the summer months as officials wait for clearer evidence that demand weakness will offset tariff increases in keeping price growth restrained.

Mexico’s peso is trading on a slightly firmer footing after the Banco de México lowered its benchmark rate by 50 basis points in a divided decision—as had been widely expected—and signalled it would ease policy at a slower pace in the months ahead. Deputy Governor Heath voted to hold rates steady—underscoring a growing hawkish tilt within the Governing Board—and officials raised their short-term inflation projections in response to still-persistent core price pressures, but they continued to pencil in a return to the 3.0 percent target by the third quarter of next year, suggesting that easing could continue for longer even as the cadence slows. Markets are anticipating a smaller, 25 basis point cut in August.

After eight consecutive rate reductions, the gap between US and Mexican policy rates has narrowed, but the currency remains an attractive outlet for the “carry trade”—in which investors borrow in low-yielding currencies to invest in high-yielders—meaning that it could have further upside potential against a subsiding volatility backdrop in the near term. The outlook looks cloudy however, with the country’s deep vulnerability to changes in US trade policy and remittance flows representing a serious downside risk. We suspect the exchange rate will begin to lose altitude once again as the autumn months approach.

In the week ahead, the data cadence will slow to a near-standstill in North America as the Canada Day and Independence Day holidays interrupt normal business activity. We will leave your inbox untouched for a few days, but will return on Thursday to cover the most important data release of the month—the US non-farm payrolls report—which could have major implications for Fed policy and the currency markets going forward.

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