August’s data on spending and inflation should put an end to the debate on whether the economy has achieved a soft landing and avoided a recession.
The Federal Reserve’s preferred measure of inflation, the personal consumption expenditures index, dropped to 2.2% on a year-ago basis, the lowest since February 2021, when the economy was still struggling with the pandemic.
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Even taking out the comparisons to a year ago, on a three-month moving average annualized pace, overall inflation was running at only 1.5% with core inflation running at only 2.1%, according to government data released Friday.
With both spending and the labor market remaining solid, this is what a soft landing looks like. Despite some hiccups along the way, the Fed has guided the economy toward a feat not seen in 30 years.
Personal income and spending
Total personal spending rose by 0.2% in August, and by 0.1% after adjusting for inflation.
While those increases were a step slower than July’s readings, the data should be solid enough to keep growth in a balance. Personal income moderated to a 0.2% increase, driven largely by lower interest, dividends and proprietors’ income. Wage and compensation growth remained strong, increasing by 0.5%.
The outlook
But the task to maintain such a delicate balance in the economy remains difficult. The decision to front load with a 50 basis-point cut looks much better in hindsight and very much in line with our earlier call that the Fed should have moved in July.
With energy prices expected to fall further while the labor market cools, there is a risk that inflation might undershoot the 2% target for the remainder of the year. The short-term three-month annualized inflation figure was under 2% in August.
The market is increasingly pricing in for another 50 basis-point cut in November and perhaps in December. Our call remains the same, for two more 25 basis-point cuts this year.
But things might change if the jobs data coming out next Friday is much weaker than expected. It is not inflation but rather the jobs data that will have the biggest effect on policy.
Inside the data, the savings rate fell slightly to 4.8% from 4.9% earlier. Still, the savings rate is inching closer to the pre-pandemic level from its bottom in 2022. Strong income growth has been an important factor helping consumers increase their savings without sacrificing too much of their spending at a time when the economy is cooling.
The takeaway
There is strong reason to be confident about growth. With the productivity boom and more interest rate cuts coming, the economy is poised to repeat the economic growth and prosperity of the 1990s over the next three to five years. The similarities are striking: a soft landing achieved amid a technology breakthrough.
