The Federal Reserve’s preferred measure of inflation continued to ease in June, reaffirming that the central bank has achieved enough price stability to reduce its policy rate at its September meeting, which has been our baseline forecast for a number of months.
The Fed has achieved enough price stability to reduce its policy rate in September.
Top-line inflation in the personal consumption expenditures index increased in June by 0.1% and by 2.5% on a year-ago basis, according to Commerce Department data released on Friday.
The core rate, which excludes food and energy, advanced by 0.2% monthly and by 2.6% on an annual basis. On a three-month annualized basis, top-line inflation has slowed to 1.5% and the core has eased to 2.3%. Supercore inflation, or services excluding housing, slowed to a 3.426% pace from 3.477% in May.
This improvement in pricing implies that a forward-looking central banker should have the confidence that inflation is well along the way to the Fed’s 2% target and conclude that it is time to cut rates.
While we would be comfortable with a cut at the Fed’s meeting next week given the improvement in the inflation data—which strongly implies that the current policy rate is overly restrictive—the Fed will most likely choose to hold its policy rate steady on July 31 and wait until September to reduce its policy rate by 25 basis points.
The data
One of the major takeaways from the spending data released Friday is that spending on services has stabilized over the past three months on a seasonally adjusted basis and is becoming less of a concern as service price inflation eases.
This stabilizing strongly suggests that household demand for services has slowed to a more sustainable pace and is the strongest illustration of just how sturdy the economy is.
Income increased by 0.2% in June while compensation advanced by 0.3% as did wages and salaries. Disposable income increased by 0.2% with personal spending rising by 0.3% and by a sustainable 0.2% on an inflation-adjusted bases.
Read more of RSM’s insights on inflation, the economy and the middle market.
Personal income excluding government transfers increased by 0.1% while disposable income saw a 0.1% gain on the moth.
Personal spending advanced by 2.6% on a three-month annualized basis while spending excluding food and energy increased by 2.9%.
The takeaway
As inflation continues to ease, it will bolster both real incomes and spending and we expect overall household consumption to advance along a 2% to 2.5% path in the second half of the year.
In addition, inflation dynamics should continue to improve as the cost of owner-occupied housing—which had eased in other higher frequency metrics—is finally beginning to show up in the official data. That long-awaited easing will bolster the case for the start of the Fed’s efforts to relax what is a too restrictive policy rate.
In the aftermath of the strong second quarter gross domestic product report released Thursday and Friday’s June PCE data, investors are now fully pricing in 25 basis-point rate cuts in September and December with strong probabilities for cuts in the November and the January meetings.
If that forward-looking market data holds, such a move implies a full 100 basis-point reduction in the federal funds rate from its current range of 5.25% to 5.5% to 4.25% to 4.5%. over the next 180 days.
