The Federal Reserve’s key gauge for underlying U.S. inflation showed only a modest increase in July, while household spending saw an uptick, solidifying expectations that the central bank will begin cutting interest rates next month.
The core Personal Consumption Expenditures (PCE) price index, which excludes volatile food and energy prices, rose by 0.2% from June, according to data from the Bureau of Economic Analysis released on Friday. Over the past three months, this measure—viewed by economists as a more accurate reflection of inflation’s trajectory—has risen at an annualized rate of 1.7%, marking the slowest pace of growth this year.
Despite the increase in spending, income growth remained sluggish, and the savings rate continued to decline. These factors raise concerns about the sustainability of consumer spending, which is crucial for economic momentum.
Friday’s data lends support to the view that it is time for the Federal Reserve to begin easing its monetary policy stance. Combined with signs of softening in the labor market, the persistent cooling of inflation justifies Fed Chair Jerome Powell’s recent statement that “the time has come” to start reducing borrowing costs, likely as early as next month.
“This report confirms that inflation is steadily cooling, reversing the reacceleration we witnessed earlier this year. This is undoubtedly positive news,” said Diane Swonk, Chief Economist at KPMG. “However, the real focus now shifts to the labor market.”
In response to the data, the S&P 500 opened higher, and two-year Treasury yields also edged up. Swaps traders maintained their outlook for the Fed to implement a series of rate cuts totaling around 100 basis points throughout 2024. Additional data from the University of Michigan indicated that one-year inflation expectations dropped to their lowest level since late 2020, though consumers continue to feel financial strain, which could impact future spending.
Fed policymakers closely monitor services inflation, excluding housing and energy, as it tends to be more persistent. This metric also increased by 0.2% in July, marking the second consecutive month of similar growth. On an annual basis, it rose by 3.25%, the slowest pace in over three years.
Federal Reserve officials have signaled a growing focus on the employment side of their dual mandate. The state of the labor market will be a key determinant in shaping expectations for consumer spending, the primary driver of the U.S. economy. The upcoming August jobs report, set to be released next week, will be the last major economic indicator available to policymakers before their September 17-18 meeting.
In July, inflation-adjusted consumer spending increased by 0.4%, accelerating from the previous month. This growth was primarily driven by goods purchases—especially motor vehicles, which saw a recovery after a cyberattack had previously disrupted sales. However, services spending grew at a more modest rate.
The report also highlighted a concerning slowdown in income growth. Inflation-adjusted disposable income barely increased for the second consecutive month, and the savings rate fell to 2.9%, the second-lowest level since 2008. Meanwhile, nominal wages and salaries grew by 0.3%, a slight improvement from June but still lagging behind the majority of increases seen in 2023.
Expanded Analysis:
The data paints a mixed picture for the U.S. economy. On one hand, the cooling of inflation provides the Fed with room to start easing monetary policy, which could stimulate economic activity and support market sentiment. However, the sluggish growth in income and the declining savings rate indicate potential challenges for consumer spending, a critical component of economic growth. Investors should monitor upcoming labor market data closely, as it will play a pivotal role in the Fed’s decision-making process. The balance between fostering economic growth and managing inflation expectations will be delicate, and the market’s response to the Fed’s actions could present both opportunities and risks for investors.
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