Spending, Inflation Reports Send Mixed Signals

Posted by Lawrence Gillum, CFA, Fixed Income Strategist

Friday, September 30, 2022

In a Word: “Disappointing”

Revisions to July real spending and mixed signals about inflation make these latest economic reports disappointing. Real spending rose 0.1%, after falling -0.1% in July. Real spending was weak in August and revised downward in July, revealing underlying weakness in the economy and increasing the odds of a recession next year.

The savings rate was 3.5% in August, unchanged from the previous month and significantly below the 2019 average of 8.8%. Consumers are tapping into savings to offset slow wage growth and nagging inflation pressures.

Perhaps an encouraging sign is falling gas prices gave consumers some margin to spend on discretionary items. Real spending on sports and recreational vehicles continues to grow as well as real spending on jewelry and watches. Demand for these luxury durable goods has been elevated since the onset of the pandemic.

Mixed Signals on Inflation

Headline inflation eased in August but core inflation accelerated, likely keeping the Federal Reserve (Fed) on track for another aggressive 0.75% increase to the fed funds rate in November.

The Personal Consumption Expenditure (PCE) deflator, the Fed’s preferred inflation metric, eased slightly to 6.2% year over year from 6.4% in July. Energy prices and meat prices pulled down the aggregate metric. The Core PCE deflator, which excludes food and energy, accelerated to 4.9% from a year ago, which was up from last month’s 4.7% reading. Services inflation rebounded in August, particularly in transportation, housing, and utilities. Although the U.S. does not have as serious an energy crisis as Europe, domestic prices for electricity and natural gas have dramatically increased for several consecutive months.

As shown in the LPL Chart of the Day, the PCE deflator normally runs cooler than the Consumer Price Index (CPI), since the PCE deflator is based on actual consumer spending and accounts for substitutions from month to month. The graph shows the economy is likely past peak inflation but the signals are far from clear.

View enlarged chart.

Waiting for Confirmation

Members of the Federal Open Market Committee (FOMC) are waiting for confirmation that inflation is easing. We think we have seen some confirmation but again the signals are far from clear. Durable goods prices, commodity prices, and import prices are all slowing and it is just a matter of time before retail consumer prices will follow. However in the near term, the FOMC has recommitted themselves to fighting inflation until it is moving back to the 2% long-run target. The market is still coming to grips with the Federal Reserve Vice Chair Lael Brainard’s warning that they “are committed to avoiding pulling back prematurely.”


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