Strong US spending dims hopes for big Fed rate cut

US consumer spending increased solidly in July, suggesting the economy remained on firmer ground early in the third quarter and arguing against a half-percentage-point interest rate cut from the Federal Reserve next month. The report from the Commerce Department on Friday also showed prices rising moderately last month, curbing inflation.

A jump in the unemployment rate to a near three-year high of 4.3 per cent in July stoked fears of a recession, leading financial markets and some economists to put a 50-basis-points rate reduction on the table when the US central bank embarks on a widely anticipated policy easing in September.

Last week, Fed Chair Jerome Powell signalled that a rate cut was imminent, in a nod to worries about the labour market.

While the labour market momentum has slowed, it continues to generate decent wage growth that is helping to underpin spending

“There is nothing here to push the Fed to a half-point cut,” said Conrad DeQuadros, senior economic advisor at Brean Capital. “This is not the kind of spending growth associated with recession.” Consumer spending, which accounts for more than two-thirds of US economic activity, rose 0.5pc last month after advancing by an unrevised 0.3pc in June, the Commerce Department’s Bureau of Economic Analysis reported. The increase was in line with economists’ expectations.

After adjusting for inflation, consumer spending gained 0.4pc after rising 0.3pc in June and implied that spending retained the momentum from the second quarter when it helped to boost gross domestic product growth to a 3.0pc annualised rate.

The economy grew at a 1.4pc pace in the January-March quarter. The Atlanta Fed raised its third-quarter GDP growth estimate to a 2.5pc rate from a 2.0pc pace.

The saving rate dropped to 2.9pc, the lowest level since June 2022, from 3.1pc in June

The increase in spending was across both goods and services, with outlays on motor vehicles and parts leading the charge. Consumers also spent more on housing and utilities, food and beverages, recreation services as well as financial services and insurance. They also boosted spending on healthcare, visited restaurants and bars and stayed at hotels.

Consumers also bought more recreational goods and vehicles as well as furnishings and long-lasting household equipment.

While the labour market momentum has slowed, it continues to generate decent wage growth that is helping to underpin spending. The slowdown in the labour market is mostly driven by a step down in hiring rather than layoffs. Personal income rose 0.3pc last month after gaining 0.2pc in June. Wages climbed 0.3pc after increasing 0.2pc in June.

Saving rate drops

The saving rate dropped to 2.9pc, the lowest level since June 2022, from 3.1pc in June. Economists were, however, not in agreement on the implications of the decline with some arguing that the government was not fully capturing income earned by undocumented immigrants.

Others argued that households were drawing down on savings to maintain spending, which could imperil future consumption. Yet another group was unperturbed by the decline in the saving rate, pointing to strong household balance sheets against the backdrop of higher house and stock prices.

Undocumented immigrants have also been cited as one of the factors behind the Labour Department’s Bureau of Labour Statistics estimate last week that employment gains were overstated by 68,000 jobs per month in the 12 months through March.

The so-called benchmark revision estimate is based on a data set derived from reports by employers to the state unemployment insurance programs. The data does not include undocumented immigrants, a group that economists believe contributed to strong job growth last year.

“The BEA could be undercounting income earned by recent immigrants, whose economic activity is harder to measure than workers who have been in the US longer,” said Bill Adams, chief economist at Comerica Bank.

“That could mean the saving rate is higher than is currently reported, and would be revised higher when more accurate employment and earnings data become available.” Stocks on Wall Street were trading higher. The dollar rose against a basket of currencies, while US Treasury prices fell.

August’s employment report, scheduled to be released this coming Friday, will likely determine the size of the September rate cut.

The personal consumption expenditures (PCE) price index rose 0.2pc last month after an unrevised 0.1pc gain in June, the report also showed. Goods prices were unchanged after falling for two straight months. Declines in the prices of motor vehicles and other long-lasting manufactured goods were offset by gains in take-out food and other nondurable goods.

The cost of services increased 0.2pc for a third straight month, lifted by rises in housing and utilities, recreation services as well as financial services and insurance. Healthcare prices were unchanged while the cost of transportation services decreased for the fourth consecutive month.

In the 12 months through July, the PCE price index increased 2.5pc, matching June’s gain. The increase in PCE inflation was in line with economists’ expectations.

Excluding the volatile food and energy components, the PCE price index rose 0.2pc last month, matching the increase in June. In the 12 months through July, core inflation increased 2.6pc after advancing by the same rate in June.

Core inflation increased at a 1.7pc annualised rate in the three months through July. The Fed tracks the PCE price measures for its 2pc inflation target, and has maintained its policy rate in the current 5.25pc-5.50pc range for more than a year, having raised it by 525 basis points in 2022 and 2023.

“The data suggest inflation is on track to hit the Fed’s 2pc target,” said Pooja Sriram, an economist at Barclays. “We maintain our baseline call for three Fed rate cuts this year.”

Published in Dawn, The Business and Finance Weekly, September 2nd, 2024