The U.S. July inflation data implies that inflation is not going gently into that good night.
While the Federal Reserve is well positioned to keep its policy rate in a range between 3.5% and 3.75% ahead of its meeting next month, the pace of household spending, capital expenditures and core inflation all imply that, absent policy action by the Fed, it is hard believe that inflation will fall back on its own to the Fed’s 2% target anytime soon.
Both headline and core inflation advanced by 0.2% on the month—although the top-line figure narrowly missed a 0.3% increase, which will keep the hawks at the Fed squawking—while on a year-ago basis prices advanced by 3.7% for the headline number and 3.3% for the core.
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On a year-ago basis, goods inflation increased by 3.7%, durables pricing advanced by 3.4% and non-durables were up by 3.9%. Service spending remained sticky at 3.7% over the past year.
Food prices were up by 3.3% and energy costs by 15.3%.
In our estimation, the underlying pace of inflation in the Fed’s preferred pricing metric looks to be just under 3%.
Given the three shocks—tariffs, war-induced energy prices an d AI-related demand for commodities and finished goods—any discussion of rate cuts should be sidelined and the risk of rate hikes are live options for policymakers who are concerned about inflation that has remained well above the 2% target for the past five years.
Personal income advanced by 0.4% while disposable income increased by 0.5% in the month in addition to a 0.3% advance in compensation, wages and salaries in July. The increase in the personal savings rate improved to 3% from 2.6% previously.
On an inflation-adjusted basis, personal spending was flat, personal income excluding government transfers advanced by 0.25% and real disposable income increased by 0.4%
Inside the revised second quarter GDP data, household spending was revised up to a 3.4% increase through midyear and gross domestic income increased by 2.2%. Both imply that the top-line growth, which was weighed down by trade-related policy distortions, is growing at a stronger pace that the 1.5% top line would suggest.
Corporate profits with inventory valuation and capital consumption adjustments increased by $400.9 billion in the second quarter, which was up by $74.4 billion over the first three months of the year. Such an increase underscores our view that the economy is doing far better than top-line GDP data implies.
That 2.2% increase in gross domestic income was aligned with the same increase in real final sales.
Gross domestic purchases were up by 2.6%, final sales to domestic purchasers was revised up to a 3.3% increase from 3.1% and final sales to private domestic purchasers, which excludes the volatile trade and inventory categories, was revised up to 4.2% from 3.9%.
All of those increases will feed into the discussion of the hawks at the Fed who continue to make the case that inflation will not easily abate on its own and move back to 2% anytime soon absent rate hikes.
Such an pricing environment suggests that the pressure will be on Fed Chair Kevin Warsh at Jackson Hole this week to delineate exactly what he plans to do, other than pledge his fealty to the Fed’s 2% target and restore price stability.
July durable goods increased by 1.1%, the core ex-transportation advanced by 0.4% and ex-defense was up by 1.3%. The primary cause of the large increase was a 12.7% increase in orders for non-defense aircraft, a 0.9% increase in vehicles and parts, and a 1.2% advance in machinery.
Fabricated metals increased by 0.4% while orders of computers and electronics dropped by 1.1% and electrical equipment declined by 0.4%.
The proxy for future capital expenditures—orders of non-defense capital goods excluding aircraft—advanced by 0.2% and increased on a three-month average annualized pace of 16.8%.
The proxy for current capital expenditures—shipments of the same goods—increased by 1.4% and were up by 12.7% on a three-month average annualized basis.
The July data implies that a historic capital expenditures boom that is largely driven by the buildout of artificial intelligence capacity remains in place but may slow somewhat.
The takeaway
While the top-line inflation data is likely set up the Federal Reserve to keep its policy rate unchanged ahead of its meeting next month, robust household spending and red-hot outlays on capital expenditures both point to an economy that is growing at a quicker pace than the trade-distorted top-line figure implies.
Simply stating that one is for price stability is far different than putting in place policy to do so.
This translates to further pressure on Warsh to further articulate his reaction function and what, if anything, he is prepared to do to restore price stability defined as the Fed’s 2% inflation target at his long-awaited policy address on Friday at the Kansas City Fed’s Economic Policy Symposium in Jackson Hole, Wyo.
Should he not do that, there is a possibility that the bond market, which is already spooked by the two verbal interventions of the U.S. Treasury over the past two weeks, may choose to push bond yields higher in the near term.
