Market Brief: US Inflation Accelerates, Spending Growth Slows

The Federal Reserve’s preferred inflation measure exhibited signs of acceleration last month even as personal spending growth slowed, providing more evidence of a “stagflation-lite” situation in the US economy. Data released by the Bureau of Economic Analysis this morning showed the core personal consumption expenditures index—which excludes food and energy costs—rising 0.3 percent in June from the prior month. On a year-over-year basis, core prices rose 2.8 percent, slightly narrowing the gap between the Fed Funds rate and underlying inflation. The overall personal consumption expenditures index also rose 0.3 percent relative to the prior month, and was up 2.6 percent from a year ago, speeding up from 2.5 percent previously. Personal income rose an as-expected 0.3 percent month-over-month, but inflation-adjusted household spending climbed just 0.1 percent, pointing to increased cautions among consumers.

This comes after policymakers left borrowing costs unchanged at the conclusion of yesterday’s meeting, even as they downplayed the economy’s strength. In the statement setting out the decision, officials warned “inflation remains somewhat elevated,” and acknowledged continued strength in labour markets, noting that the “unemployment rate remains low,” but also suggested that they were growing more wary of downside risks. “Although swings in net exports continue to affect the data,” they said, “recent indicators suggest that growth of economic activity moderated in the first half of the year”. Data published yesterday morning confirmed a steep decline in private sector activity in the first half of the year as soaring policy uncertainty impacted business and consumer spending levels.

Governors Michelle Bowman and Christopher Waller dissented, marking the first time since 1993 that two governors broke from the majority in objecting to a rate decision. Although this was well-telegraphed and may have reflected political maneouvering as the president’s appointees vie for influence—a dynamic reminiscent of Paul Volcker’s tenure as chair—rather than a fundamental shift in the majority’s stance, it nonetheless laid the groundwork for a potential dovish turn in the coming months should labour market conditions worsen significantly.

But Chair Powell offset the impact on markets by sounding slightly more hawkish in the post-decision press conference, suggesting—to us, at least—that he was trying to keep the central bank’s options open for now. In speaking with reporters, Powell acknowledged growing “downside risk” in the job market, but noted that unemployment rates were holding steady as demand for workers slows in line with supply, and said “inflation is further from our goal than unemployment,” suggesting that most officials see risks asymmetrically tilted toward the price-stability side of their dual mandate. “It seems to me—and to almost the whole committee—,” he said “that the economy is not performing as though restrictive policy is holding it back inappropriately”. Ahead of his comments, interest-rate traders had been pricing in a two-thirds chance of a cut in September, but this fell to less than half before he concluded.

The trade-weighted dollar is up against most of its rivals from yesterday morning’s levels, Treasury yields are slightly higher across policy-sensitive tenors, and equity markets are off to a solid start, propelled by a solid set of earnings reports from many of the world’s biggest technology firms.

Here in Canada, the economy contracted for a second consecutive month in May, and eked out a modest expansion in the following month, suggesting that elevated levels of trade uncertainty are taking a toll. According to data just published by Statistics Canada, gross domestic product fell -0.1 percent in May, with a modest recovery in inventory accumulation and in real estate activity failing to offset a broader retreat, with just seven of 20 industrial sectors expanding. An early estimate showed growth staging a mild rebound in June, but the increase amounted to just 0.1 percent—a pace that would put the economy on course for a 0.1-percent annualised growth rate in the second quarter, down from 1.6 percent in the first three months of the year. A separate release showed job vacancies falling by 4.1 per cent in month-over-month terms in May, bringing worker demand to the lowest level recorded since October 2017. The Canadian dollar is suffering as policy rate expectations against the US diverge, and as traders brace for more negativity from south of the border, where Donald Trump this morning said that Ottawa’s decision to recognise Palestinian statehood could frustrate attempts to achieve a trade deal with the United States. Our short-term call for a touch of the 1.39 level remains intact.

The Bank of Japan left rates unchanged last night, and Governor Ueda avoided telegraphing further rate normalisation over the year ahead. Policymakers acknowledged “positive developments in trade and other policies, such as negotiations between Japan and the United States” that could help reduce downside risks to the economy, and now expect to see core consumer price growth running at 2.7 percent in this fiscal year, up from 2.2 percent previously. The Governor downplayed the impact on the central bank’s policy settings however, noting that food prices are driving the acceleration in inflation, and pointing to elevated levels of political policy uncertainty as a good reason to stay on hold for now.

The week isn’t over yet. Today, headline risks could arise as the US Court of Appeals for the Federal Circuit hears oral arguments for and against President Trump's authority under the International Emergency Economic Powers Act of 1977 to issue tariffs. Although tomorrow’s non-farm payrolls report could prove uneventful if job creation holds firm, a downside miss could trigger a landslide in currency markets as early-autumn rate cuts are put back on the table. And with the White House’s tariff pause set to expire tomorrow, currencies issued by countries without an announced “deal”—including the Canadian dollar—could experience turbulence.

Please note: Distribution of the daily Market Briefing will pause between August 4 and August 15 as I prepare for an extremely busy speaking agenda this autumn. I will, of course, send breaking news updates if any major market-moving developments occur.

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