The Fed’s preferred measure of inflation remained high in July – and consumers continue to spend

Minneapolis
CNN
—

US inflation may have remained high in July, but consumers just wanted to have some fun.

New Commerce Department data released Thursday showed that consumer spending jumped 0.8% last month as shoppers flocked to restaurants, live shows, toys, games and entertainment equipment. It is the strongest monthly increase in spending since January. However, the underlying data suggests that this type of activity may be on borrowed time.

The personal income and expenditure report for July also showed that the Fed’s preferred measure of inflation remained high but grew at a monthly rate more in line with the central bank’s 2% target.

The personal consumption expenditures index showed that prices rose 0.2% on a monthly basis and 3.3% on an annual basis.

Excluding the more volatile energy and food prices, the core PCE index showed that prices rose 0.2% from the previous month and 4.2% for the 12 months ending in July.

Economists had expected monthly increases of 0.2% for the main and core indices and 3.3% and 4.2%, respectively, for the annual figures.

“For the Fed, the best news from this release was the relatively large decline in the commodity price index even as commodity consumption remained strong,” Eugenio Aleman, chief economist at Raymond James, wrote in a note. “On the other hand, the consumption of services and the price paid for services will continue to be the biggest concern of Fed policymakers.”

Commodity inflation fell for the third consecutive month in July, falling by 0.3%.

The higher annual readings for the personal consumption expenditures indices can be attributed to “base effects”, or comparisons to a period last year when inflation was cooling after a 40-year high. This was similarly seen in the July CPI report, which saw a slight pickup in annual inflation rates but a more modest monthly gain of 0.2% that’s more in line with where the Fed would like to see inflation.

“Make no mistake, the monthly sequential momentum around 0.2% is exactly what Fed policymakers are looking for to bring inflation back toward the 2% target,” Gregory Daco, EY’s chief economist, wrote Thursday.

A headline inflation rate of 3.3% was largely expected after Federal Reserve Chairman Jerome Powell made the data point in his economic outlook speech in Jackson Hole, Wyoming, last week. He said core inflation remains well above the Fed’s 2% target.

“Sustainably bringing inflation down to 2% is expected to require a period of below-trend economic growth as well as some softening in labor market conditions,” Powell said.

The latest data underscores how the American consumer remains resilient and continues to drive economic growth. Even adjusted for inflation, spending rose in July, up 0.6% from the previous month.

The rise is in line with other spending data released earlier this month that showed retail sales rose 0.7% in July from the previous month, according to Commerce Department data that is adjusted for seasonality, not inflation. July retail sales got a boost thanks to Amazon’s Prime Day, which contributed to a stronger-than-usual display of “out of store” retail sales for the month.

Thursday’s personal consumption expenditures data, a more comprehensive look at how consumers buy a wide range of goods and services, showed spending was mostly broad-based — including on goods, a category that has been weaker for much of last year. Nondurable purchases rose by the most in 10 months, and durable goods and services rose at the fastest pace in six months, economists at Wells Fargo wrote in a note issued Thursday.

While on the face of it the fed data appears to be at odds with the sales decline reported by retailers such as Home Depot (HD), Target (TGT) and others, it is possible that the gains seen were a result of the monthly “noise”. Shannon Seery, an economist at Wells Fargo, told CNN that the data is volatile. She added that some consumers may not yet fully feel the effects of higher interest rates.

However, the basis of this spending is showing some cracks.

Personal income showed some weakness last month, growing just 0.2% from June, the smallest monthly increase since January 2022. Unadjusted disposable income was flat and, when inflation was taken into account, turned negative at 0.2%.

The personal savings rate fell to 3.5% in July from 4.3% the previous month, pushing savings to their lowest level since October 2022.

“While the aggregate data keeps the pressure on the Fed, I think the expectation is that spending will slow from now,” Siri said. “I think the runway there is diminishing very quickly in terms of how well households can continue to rely on that liquidity.”

Thursday’s data is not expected to shake expectations that the Fed will pause at its next meeting, she said, nor does it completely rule out a potential moderate recession from the picture.

However, the bulk of this week’s economic data is yet to be released. On Friday morning, the Bureau of Labor Statistics is scheduled to release its August jobs report. Economists expect job growth to continue to slow, with employers adding 170,000 jobs this month and the unemployment rate holding steady at 3.5%, according to Refinitiv.

“The latest evidence of slowing consumer spending, easing labor market tightness, cooling wage growth momentum, and slowing core inflation reinforces our expectations that the Fed’s tightening cycle is over, even if policymakers keep the door open for further tightening,” Daco said.

“Chairman Powell highlighted during his Jackson Hole speech that signs of above-trend growth or evidence of labor market tightness not easing could warrant further tightening of monetary policy. Fortunately, neither condition is in place.