Inflation cools

The tepid inflation figures underscore why the Fed was so confident. 

The personal consumption expenditures (PCE) index, which the Federal Reserve targets, rose a tepid 0.1% in August, half the pace of last month. The figure was 0.09% before rounding, which is better than expected. This marks the fourth consecutive month with inflation at 0.2% or less. That is the longest span of tepid inflation figures since the onset of the pandemic, before widespread supply chain problems.  

The overall PCE index rose 2.2% from a year ago, 0.3% below the pace of July, also better than expected. The improvement in inflation is broader based than we saw just a year ago with discounting putting downward pressure on many goods prices. Everything from the pushback by consumers on price hikes to increased productivity growth, the strong dollar and excess capacity abroad is keeping the pressure on prices.  

Separately, oil prices continued their downward trend in August and September. That should provide a headwind for inflation in September.  

The core (excluding food and energy) measure of the index only rose 0.1%, half the pace of July. The core index is up 2.7% from a year ago, the same as July; the data for July were revised up slightly.  

The math on year-on-year measures of the core index gets harder in the back half of 2024 due to the rapid improvement in inflation we saw in the second half of 2023. Those “base effects,” as they are known, drop out of the data in January. The Fed knows that and is paying closer attention to the momentum in the index, which is very close to the Fed’s 2% target when measured on 3-month and 6-month annualized paces.  

The super core services index, which strips out energy services and shelter costs, rose 0.2% in August, the same as last month. That translates to 3.3% from a year ago, a tick above the annual pace of July. The super-core services have cooled significantly since the start of the year and are showing much less stickiness here than abroad. Wages are outpacing inflation, but not adding to service sector inflation, which is yet another reason the Fed is comfortable cutting rates. 

The largest contributors to service sector inflation were childcare, personal care (haircuts and miscellaneous personal services) and hotel room rates. Rents for apartments rose 0.4%, a tick lower than last month. Owners' equivalent rents rose 0.5%, another tick higher than last month. Overall rents have cooled from earlier in the cycle, but lags in lease renewals mean that the cooling effect they have on shelter costs appears with a substantial delay. Weaker shelter costs are in the pipeline. 

Hurricane Helene has hit Florida and caused massive flooding and destruction. The state is one of the few places with excess inventory in homes, condos and apartments. That should help blunt the effects of the devastation on the inflation figures.  

Consumer spending has picked up on the heels of discounting, which is the very definition of a soft landing.

Spending aligns with incomes  

Personal disposable incomes rose 0.1% after adjusting for inflation in August, the same as July. Consumer spending rose 0.1% in August, one quarter of the robust pace of July, when vehicle sales delayed by a hack at dealerships were recouped. Spending for the quarter is still strong and on track to accelerate in the third quarter from the second quarter. 

The savings rate came in at 4.8% in August, a bit lower than the 4.9% of July. The initial savings rate for July was reported at 2.9%. That suggests that consumers have much more of a cushion going into the falling as than previously thought.  

Large revisions to the saving rate are common, as it is merely a residual and not what consumers have in their savings accounts. Those upward revisions are important when combined with the rise in wealth, which now covers a broader array of households.  

Bottom Line  

Consumer spending has picked up on the heels of discounting, which is the very definition of a soft landing. The tepid inflation figures underscore why the Fed was so confident that inflation was moving close to its target when it cut by half a percent in September. At least another half percent in cuts is expected by year-end. An unusually weak employment report for September could tip the scales in favor of larger cuts.