US economy Pickup in US inflation unlikely to provoke the Fed

On an annual basis, the rate of inflation picked up to 3.7% in August from 3.2% the month before.

Even the core rate of inflation, excluding food and energy, rose slightly on a monthly basis to 0.3% from 0.2% in each of the prior two months. The data underline our view that the low-hanging fruit on inflation has probably already been plucked and the path back to the Federal Reserve’s 2% target may not be a straight one.

But, much of the disappointing news in the data was more superficial than real. Overall, we still believe the US in on track for a softish landing, with moderating inflation permitting the Federal Reserve to stop rate hikes before tipping the US into a recession.

Beneath the surface, the trend toward moderating inflation remains intact. In year-over-year terms, core inflation slowed to 4.3%, from 4.7%in the prior month, for a fifth consecutive monthly decline. This was also the slowest rate since September 2021.

On a headline basis, more than two-thirds of the annual rise was driven by shelter, which we can be confident will moderate as recent figures on new rental agreements point to only minimal price increases. Excluding shelter, the inflation rate was a subdued 1.9% year-over-year—in line with the Fed’s target. And while shelter prices were up 7.3% year-over-year, they rose only 0.3% month-over-month, the smallest increase since March 2021.

The labor market is cooling, but not too abruptly. August payrolls also pointed toward a gradual rebalancing in the US labor market. The economy created 187,000 new jobs over the month, only a little higher than the consensus forecast for 170,000—with a downward revision of a cumulative 110,000 for the prior two months. Monthly wage growth was also slower, and unemployment rose to 3.8%, versus expectations that it would remain steady near multi-decade lows of 3.5%. That was the final major jobs release ahead of the Fed’s decision and would be consistent with an end to rate rises, in our view.

Consumer spending appears on track to slow, with the downside being limited by strong household balance sheets. Investors will be getting an update on the state of American consumers with August retail sales data, released on 14 September, which followed an unexpectedly strong 0.7% monthly rise in July. The consensus forecast is for a moderation. Overall, we expect consumer spending to weaken, since much of the excess savings accumulated during the pandemic have been spent by lower-income households, while savings rates remain well below historical norms and look likely to rise. With real wage growth still low despite moderating inflation, the capacity of households to increase spending looks limited.

However, we still expect strong balance sheets among wealthier Americans to underpin spending to some degree. Fed data on Friday showed household net worth rising to a record high of USD 154 trillion for the second quarter, reflecting gains for homeowners and those with equity investments.

So, the latest data support our view that the US economy is headed for a period of moderate growth, avoiding a recession over the coming 12 months. That should support equities. However, uncertainty is likely to keep broad equity markets choppy and rangebound. Against that backdrop, we favor equity laggards, including more defensive sectors and emerging market stocks.

Main contributors - Solita Marcelli, Mark Haefele, Brian Rose, Christopher Swann, Vincent Heaney, Jon Gordon

Original report - Pickup in US inflation unlikely to provoke the Fed, 14 September 2023.