This week’s economic data is expected to reflect a resilient U.S. consumer, supported by easing growth in rent, food and gas prices. With a smaller share of loan officers reporting tightening lending standards, bank lending isn’t likely to be a drag going forward either.
But will inflation continue to decline? Has the Federal Reserve implicitly raised its inflation target?
July’s retail sales and both existing and newly built home sales data surprised on the upside, aided by easing inflation and mortgage rates. Consumer spending remains robust, as the upcoming Personal Income and Outlays report is likely to show. Personal savings remain low, and personal consumption is expected to have increased by 0.5% in July, up from 0.3% in June. Personal consumption was 5.2% higher than a year ago in June, down only barely from 5.3% in May. The Fed’s preferred inflation gauge, the Core PCE price index, is anticipated to have risen by 0.2% in July, unchanged from the previous month.
While the Fed’s readiness to cut interest rates at their next meeting is welcome news, there’s little in the economic and financial data to suggest significant further disinflation.
First, the stock market has mostly recovered from an early August sell-off and returned to mid-July highs. Treasury yields have fallen, causing financial conditions to ease significantly in August. Layoffs remain near record lows, and with slowing population growth, labor supply will soon hit a wall, limiting further wage disinflation. Additionally, fiscal policy is expected to be inflationary by pushing spending higher without offsetting tax increases that lower households disposable incomes.
In short, while monetary policy may be restrictive, it may not be so restrictive to justify substantial Fed rate cuts. Markets currently expect the Fed funds rate to fall to 3.25-3.5% by the end of next year. However, if my assessment is correct, long-dated Treasury yields may already be near the bottom.
