Disinflation, strong household consumption and incomes rising above the rate of inflation continue to be the defining narrative of the U.S. economy as it heads into the second half of the year.
With the Federal Reserve’s preferred measure of inflation, the personal consumption expenditures index, rising by a 2.5% annual rate in July amid signs of further disinflation, price stability has been re-established across the American economy.
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In addition, the July data supports the coming policy pivot by the Federal Reserve toward reducing the restrictive federal funds rate, which will provide relief for households looking to refinance and firms that have been waiting to finance expansion.
All of these dynamics bode well for the current economic expansion.
The data
The PCE index increased by 0.155% in July, and by 2.5% (or, more precisely, 2.496%) from one year ago, according to Commerce Department data released Friday. On a three-month average annualized basis, the PCE index increased by 1.6%
Goods prices were flat on the month, durable goods prices declined by 2.5%, nondurable prices advanced by 1.3% and service costs eased by 3.7%.
Core prices increased by 0.161% on the month, by 2.6% on a year-ago basis and by 2.2% on a three-month annualized basis.
Food prices increased by 1.4% and energy costs rose by 1.9% while the market-based PCE increased by 2.3% and the market-based core rate rose by 2.4%.
All of this points to the re-establishment of price stability across the American economy.
Personal spending jumped by 0.5% and spending adjusted for inflation increased by 0.4%. On a three-month average annualized basis, personal spending increased by 3.8%.
Personal income increased by 0.3%, income excluding government transfers advanced by 0.2% and disposable income rose by 0.1%. Compensation and wages and salaries both increased by 0.3% while the savings rate eased to 2.9%.
Policy implications
The July data reinforces the idea that the Federal Reserve is sufficiently confident that the PCE index, its preferred metric, is on a path back to the Fed’s 2% target.
The 0.9% three-month and 2.3% annual pace of inflation provides a look into pricing dynamics that should unlock pent-up demand for deferred business investment, consumer goods and a wave of refinancing as the policy rate begins to decline this fall.
We expect the Fed to make a string of 25 basis-point rate cuts starting at the September meeting before the policy declines to around 3.25% in the second half of next year.
The takeaway
The goods channel is showing sustained disinflation as service prices ease and wages continue to increase above the rate of inflation, all of which supports strong household spending.
The American economy is poised to grow at or above the long-term 1.8% rate as the Fed begins its rate-cutting campaign, which should put a floor under growth and hiring.
This data supports risk taking by the commercial sector as rates come down and by investors, who are now looking at a sustained increase in the economic expansion.
