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Federal Reserve policymakers said Wednesday they wanted more evidence that inflation is subsiding before cutting interest rates. A day later, they get some.

Two reports out Thursday showed May jobless claims jumped to their highest level since August 2023 and that wholesale prices unexpectedly dropped last month.

An estimated 242,000 workers filed initial claims for unemployment insurance during the week ending June 8, the Department of Labor reported, up 13,000 from the week before and close to 20,000 more claims than forecast by economists.

Initial jobless claims surge

“Initial claims have been drifting up for some time, but the big increase this week leaves the uptrend far harder to dismiss,” Pantheon Macroeconomics Senior U.S. Economist Oliver Allen said in a note to clients.

“High long-term rates, tight credit conditions and a gradual softening in demand are starting to weigh more heavily on businesses, and on small companies in particular,” Allen said. “Greater layoffs will probably mean that the labor market starts to look a lot weaker very soon, especially when combined with the meaningful slowdown in gross hiring suggested by most of the business surveys.”

Thursday’s wholesale prices report, formally known as the Producer Price Index (PPI), tracks demand, prices and profit margins for goods ranging from diesel fuel to eggs and services like freight and cargo transportation.

The PPI for final demand fell by a seasonally adjusted 0.2 percent in May, the Bureau of Labor Statistics reported Thursday. Economists had expected headline PPI to moderate from the 0.5 percent increase registered in April but projected the index would still manage to eke out 0.1 percent growth in May.

Bond market investors — who had already sent mortgage rates plummeting Wednesday after the latest Consumer Price Index reading showed inflation easing in May — kept the rally going Thursday, bringing 10-year Treasury yields down another 6 basis points.

Mortgage rates trending down

Rates for 30-year fixed-rate mortgages, which are largely determined by investor demand for mortgage-backed securities, dropped 14 basis points on Wednesday, to 6.84 percent, according to rate lock data tracked by Optimal Blue. A basis point is one-hundredth of a percentage point.

That’s a 43 basis-point drop from a 2024 high of 7.27 percent registered April 25, and mortgage rates are likely to keep tracking down with 10-year Treasury yields, a barometer for mortgage rates. An index maintained by Mortgage News Daily showed rates for 30-year fixed-rate loans eased again on Thursday, but only by a single basis point.

Key Fed inflation metric set to drop June 28

But mortgage rates have now come down nearly half a percentage point from this year’s highs — and could be poised for another big drop when the Federal Reserve’s preferred inflation gauge, the Personal Consumption Expenditures (PCE) price index, is updated on June 28.

CPI and PPI are key components of the PCE price index. Now that the latest CPI and PPI numbers are out, forecasters at Pantheon Macroeconomics have run the numbers for what core PCE — which excludes food and energy costs — might look like when the numbers for May are released in two weeks.

Fed policymakers took some of the momentum out of Wednesday’s CPI-fueled bond rally when they released economic projections indicating that they only expect to cut rates once this year, by 25 basis points. The Fed wants to see more evidence that inflation is moving toward its 2 percent annual target before cutting rates more drastically, Chair Jerome Powell said.

The Fed’s latest forecasts imply they expect core PCE to rise at an average pace of 0.19 percent each month from May through December, Pantheon Macroeconomics Chief Economist Ian Shepherdson said in a note to clients Thursday.

But Pantheon’s mapping of PPI and CPI data suggests core PCE increased by just 0.11 percent in May — a drastic slowdown from the 0.32 percent average increase in the first four months of 2024.

“We don’t know what policymakers specifically penciled in for May, but our estimate points to a material downside surprise,” Shepherdson said. “Meanwhile, the outlook for slower rent gains, falling wage inflation, and margin compression at retailers suggests that the core PCE deflator will continue to rise more slowly than the Fed predicted this week, laying the foundations for the first rate cut to come in September and multiple easings this year.”

When last updated, the full PCE index was up 0.26 percent from March to April, and 2.65 percent from a year ago. That’s much closer to the Fed’s 2 percent inflation target than in June 2022, when inflation peaked at 7.12 percent.

Pantheon Macroeconomics forecasters predict the Fed will ultimately cut the short-term federal funds rate by 1.25 percentage points this year, starting with a 25 basis-point cut in September followed by 50 basis-point reductions in November and December.

While that’s more aggressive than many forecasts, futures markets tracked by the CME FedWatch tool on Thursday put the odds of two or more Fed rate cuts by the end of the year at 71 percent, up from 53 percent on May 13.

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Email Matt Carter