The U.S. personal income and spending report for April came in slightly stronger than expected overall, which will fuel discussion of another rate hike by the Federal Reserve at either the June or July meeting.

Incomes rose 0.4% month-over-month, as expected, with wages and salaries up 0.5% month-over-month, while spending rose 0.8% versus the consensus of 0.5%, with an upward revision to March.

As a result, real consumer spending is at 0.5% versus the expected 0.3% in the previous month. This will inevitably lead to an upward revision of GDP expectations for the second quarter, as consumer spending accounts for two-thirds of economic activity as measured by GDP.

Regarding inflation, the core PCE deflator is now 0.4%/4.7% instead of the expected 0.3%/4.6%. This increase will inevitably reinforce the view of Fed hawks like James Bullard and Neel Kashkari that policy needs to tighten to ensure inflation returns to the 2% target in a timely manner.

United States Core PCE Price Index Annual Change

While the expectations are that inflation will moderate sharply in the second half of the year, there are doubts that the Fed will have the patience to hold off on a hike, especially if the spending side holds up as well as it seems to be doing.

So, if the debt ceiling drama comes to a positive conclusion and jobless claims are around 200,000 next Friday, the odds are in favour of a 25 basis point rate hike in June.

Also, there’s a rapid weakening of corporate pricing power (led by deteriorating economic sentiment) suggests that markets should expect a sharp slowdown in inflation in the second half of the year – the problem is that we do not trust the Fed to wait for that.

The fears are that the likely outcome will be an excessive tightening of monetary policy, which, combined with much tighter lending standards that will restrict the flow of credit, will plunge the economy into a potentially painful recession.

The conclusion, therefore, is that this will lead to an even bigger interest rate cut story in the future.