Geopolitical developments continued to grab headlines this week. However, the world breathed a sigh of relief when Pres. Trump announced a ceasefire between Israel and Iran on Monday. Oil prices fell sharply on the news, while equity markets rallied. This was followed by what appeared to be a successful NATO summit, where most members agreed to increase defense spending targets to 5% of GDP by 2035. Some good news also trickled in on the trade front, with China pledging to approve applications for rare-earth exports to the U.S. – a development that could pave the way for more fruitful trade negotiations. These developments appeared to overshadow more muted developments on the home front. 

The passage of the ‘One, Big, Beautiful Bill Act’ hit a snag in the Senate, ahead of Thursday’s vote. The Senate parliamentarian reportedly ruled out several major measures in the legislation, most notably provisions related to Medicaid cuts – complicating the GOP’s math on spending cuts. It remains unclear if the bill will pass by the Republican’s self-imposed deadline of July 4th. 

On the data front, the highlight of the week was the May release of personal income and spending. Personal income fell by 0.4% month-on-month (m/m), owing to a sharp pullback in transfer payments. Importantly, compensation to employees – nearly two-third of income – rose by a healthy 0.4% m/m. However, there were definite signs of waning consumer resilience. Goods spending fell 0.8% m/m, while services were flat on the month, with total spending down 0.3% on the month (Chart 1). Part of the softening in services spending was telegraphed earlier in the week in the third release of Q1 GDP, where it was revised to just a 0.6% gain (previously 1.7%), implying less momentum heading into Q2. 

So far, the tariff impacts on inflation have remained relatively contained. While core PCE inflation – the Fed’s preferred gauge – heated up a touch in May, the monthly gain was due to relatively equal contributions from goods and services prices, pushing the year-on-year to 2.7% (Chart 2). Over the coming months, tariff impacts are expected to intensify, though the extent of price passthrough remains uncertain. Driving this point home, Chair Powell maintained a cautionary stance during his semiannual testimony to Congress this week, stating that he expects policymakers to stay on hold until they have a better handle on the impact tariffs will have on prices. This came in contrast to other Fed speakers, including Governor Waller and Bowman, who both noted that they support a July rate cut. 

The growing divide among policymakers’ is shaped by differences in the expected passthrough from tariffs and underlying labor market conditions. Waller is of the view that the tariffs wont significantly boost inflation and that because of monetary policy’s long and variable lags, the Fed should proactively cut rates to head off potential downside risks to the labor market. However, Powell and others are of the view that the labor market remains in a good spot and need to see more definitive signs of softening before pushing ahead with rate cuts. This puts next week’s employment report in the spotlight.