Inflation is still cooling

July 26, 2024

The personal consumption expenditures (PCE) index rose 0.1% in June, after being revised up slightly in May. That puts the year-over-year measure at 2.5%, the lowest since January and February. The three-month annualized pace was 1.5%, down from 2.6% the month prior. The six-month annualized pace came in at 3%, only a tick lower than May. The six-month pace is still elevated because it included the pop at the beginning of the year. Figures on momentum going forward are expected to slow as January falls out of the data, something the Federal Reserve is well aware of and betting on.

Goods prices dropped on the heels of lower energy costs during the month, while service sector prices continued to post gains. Core goods prices edged up slightly after falling last month. We need to see a further drop in goods prices to get overall inflation back to the Fed’s 2% target. A strong dollar and excess capacity abroad should help accomplish that goal by lowering the cost of imported goods. The larger hurdles are tariffs, recently enacted and those proposed for 2025.

The Fed is focused on the momentum of the inflation data in the back half of the year. The year-on-year measures will be temporarily distorted to the upside given the rapid improvement we saw in inflation in the second half of 2023. Chairman Powell has warned about that.

The core PCE (excluding food and energy) rose 0.2% in June, slightly faster than the pace of May. The index rose 2.6% from a year ago, the same as May. The three-month annualized pace dropped to 2.3% from 2.9%. That is the coolest it has been since December 2023. The six-month annualized pace was 3.4% in June, up slightly from the 3.3% pace in May. Again, those figures should cool further as we move further into the summer months.

The super core services measure of inflation, which strips out shelter costs and accounts for about half of the core PCE, has proven the stickiest. It rose 0.2% in June, the same as last month. The super core rose 3.4% from a year ago, after rising 3.5% in May. It had been stuck at a 3.5% pace for three months The three-month annualized pace slowed to 2.7% from 3.6% last month. The six-month annualized pace edged down to 4.1% from 4.2%.

Legal services were up 4.8% in June, the largest monthly increase on record. Food services rose 0.4%, buoyed by increases at sit-down restaurants and bars. Fast-food chains launched discounts during the month. Health insurance was up the most since prices reset in January. 

Homes for the elderly and mental health and substance abuse residential centers both saw significant increases. Household maintenance costs were also up. Those span cleaning, lawn and moving services.      

Homeowners got a brief reprieve after staggering increases earlier in the year. Vehicle insurance costs also abated. Other services from airline fares to vehicle leases dropped in price. We are seeing that show up as margin pressure in earnings announcements. Nursing home care fell.

The challenge will be year-over-year measures in that half, which will be buoyed by a sharp improvement in inflation in the back half of 2023. Chairman Jay Powell explained that at his press conference in June and will no doubt reiterate it following the Fed’s meeting next week.  The stickiness we are seeing in services is the prime reason that the Fed is holding out for a few more months of data before members feel “confident” to cut rates. Next week is not on the table but September remains in play.

Real disposable incomes edged up 0.1% in June, one third the pace of May. Personal consumption expenditures rose 0.2%, half the pace of May. Gains were concentrated in goods over services. Vehicle sales were the outlier due to the cyber attack on about 50,000 auto dealers in late June. Incentives on new vehicles were sweetened in recent weeks to unload what are now overflowing dealer lots.

The saving rate edged down to 3.4% from a downwardly revised 3.5% last month. June savings is at the lowest level since December 2022. Homeowners are tapping the equity in their homes to buoy spending on everything from appliances to furniture and remodeling projects. Low-income households have depleted all the savings they amassed in the wake of the pandemic and then some.  

Those shifts have left many feeling further stressed as the record rates on their credit cards compound. They need to see much more sustained increases in their wages above the pace of inflation to regain ground lost to inflation earlier in the recovery. It is in this way that the aggregate data can mask the underlying stress many are still feeling when it comes to the level of prices. 

The challenge for the Fed is to get to 2% inflation. The cost of living will not fully recede from the purchasing decisions of many consumers until they can move beyond the challenge of high price levels. The key is to do that without tipping the apple cart and causing undo pain in labor markets.