Fed Inflation Targets on Track, But Concerns Persist

The Federal Reserve’s favoured inflation gauge, the core Personal Consumption Expenditures (PCE) deflator, came in at 0.2% month-on-month, in line with expectations. Year-on-year inflation held steady at 2.6%, slightly below the predicted 2.7%. With a 0.161% monthly increase, inflation remains on track to reach the Fed’s 2% annual target by early next year, supported by three consecutive months of favourable data and a 3-month annualised inflation rate now below 2%.

However, the report revealed a complex economic picture. Real consumer spending surged 0.4% month-on-month, surpassing the 0.3% forecast, with upward revisions for the preceding months. This stronger-than-anticipated spending trajectory suggests that real consumer spending could reach a 3.4% annualized rate in the third quarter, complicating the Fed’s decision on rate cuts. The spending strength may deter the Fed from implementing a more aggressive 50 basis point (bp) rate cut on September 18, as originally speculated.

On the other hand, income growth remains concerningly weak. Real household disposable income rose just 0.1% month-on-month, unchanged from June. With the savings rate dropping to 2.9%, a level not consistently seen since before the Great Financial Crisis, questions arise about the sustainability of consumer spending. Analysts warn that reliance on savings and debt to finance expenditures could lead to economic strain, especially if unemployment continues to rise.

The upcoming jobs report will be pivotal in determining the Fed’s next move. If payroll numbers fall below 100,000 and the unemployment rate climbs to 4.4% or higher, a 50bp rate cut seems likely. However, if payrolls meet the 150,000 forecast and unemployment remains at 4.3% or dips to 4.2%, the Fed may opt for a smaller 25bp cut.

The path forward for monetary policy remains uncertain, as the Fed balances strong consumer spending with weak income growth and potential labor market challenges.