Small business sentiment fared worse than anticipated in August, more than retracing its July improvement. The NFIB (National Federation of Independent Business) index dropped 2.5 points to a three-month low of 91.2, but the real story wasn’t in the headline. It was the outsized decline in some of the components that could signal another round of deterioration ahead. The NFIB index has long been the “black sheep” so to speak among US macro indicators in that this metric has bucked the otherwise broad-based improvement seen elsewhere (for instance, in GDP and unemployment statistics). It had been languishing near multi-year lows since mid- 2022 as inflation spiked and labor shortages besieged employers, and it has only shown visible improvement in the last couple of months. The August update puts the sustainability of that incipient revival into question. Perhaps the most worrisome detail was the steep collapse in the current profitability metric. Not only was the sequential deterioration large, but it left this component at the lowest level since the Great Financial Crisis (GFC), edging out even the Covid extreme lows. One month never makes a trend, but the trend had already been downward, so this warrants close scrutiny. The combination of shrinking profits and elevated uncertainty does not bode well for either capex or hiring. This is especially true given that sales expectations, which bounced up last month, pulled back rather sharply. And it is already showing in the employment metrics. Current employment declined to the lowest level since August 2022 and hiring intentions cooled. This ties well with the recent softness in employment shown by the payrolls report. All in all, a cautionary message from the small business community.

The August inflation data largely met our and market expectations and, in the initial aftermath of the release, appeared to cement expectations for a typical 25-bp rate cut from the Fed on September 18. This had already been our expectation, and we still stick to it, although the odds of a larger move have risen again in light of what appears to be indirect signaling (via Wall Street Journal) from FOMC that the size decision is, indeed, a close call. Overall consumer prices rose 0.2% and core (excluding food and energy) prices increased 0.3% m/m. The headline inflation rate eased four tenths to 2.5% y/y, the lowest since February 2021. The core inflation rate was unchanged at 3.2% y/y.
In all fairness, we were a little surprised to see persistent softness in used car prices, which declined 1.0% m/m and are now down 10.4% y/y. The reason is that auction data via the Manheim index show auction prices down just about 4.0% y/y and typically, the two move fairly closely together. Admittedly, the CPI data follows Manheim with a lag, but that lag is usually just a couple of months so we could get a little payback to the upside in September. Elsewhere, both food and energy prices were tame and medical services declined for the second month in a row, which we did not expect. On the other hand, shelter inflation came in higher than anticipated, driven by a reacceleration in owners’ equivalent rent (0.5% m/m) and a 1.8% bounce in lodging away from home. The OER uptick is frustrating in the context of moderating market rental inflation, but it was at least accompanied by a step down in rent of primary residence. Other categories were a mixed bag. Vehicle insurance costs increased 0.6% m/m—half July’s pace—and allowed the inflation rate to ease to 16.5% y/y. This is still extremely high but down notably from 22.6% y/y in April. By contrast, following five consecutive declines, airfares jumped 3.9% m/m. Given airlines have cut back on seat availability in the fall, we could see further gains here, although they could be offset by lower oil prices which may allow airlines to protect margins without raising prices.
As we concluded following the July CPI data, we think that the Fed has what it needs to deliver a 25 basis point cut next week. But there wasn’t enough here to call for a larger cut, and with the same message coming from the August payrolls report, a 25 bp cut and a dot plot showing 75 bp worth of 2024 cuts, plus 125 bp more in 2025 is out baseline expectation for the September 18 Fed meeting.
That said, a Wall Street Journal Thursday authored by Nick Timiraos (widely seen as the “Fed voice”) weighed arguments for a 25 vs 50 bp cut fairly evenly. On cue, having priced out the 50 cut almost entirely earlier in the week, the market shifted to almost even odds on Friday. There is a fair amount of data released on Monday and through Wednesday morning, which we believe will still sway the Fed in favor of a 25 bp move, but at this point, the outcome is pretty open. In reality, it won’t matter a whole lot, though going 50 would open the Fed to accusations that it may be unduly influencing the impending election. It would also be an implicit recognition that the FOMC had been wrong in its assessment of the economy at the June/July meetings.
On the other side of the policy spectrum, the fiscal picture remains frightening. The budget deficit ballooned to $380.1 billion in August, pushing the fiscal-year-to-date (October to August) deficit to $1.897 trillion and easily on track to exceed the $2.0 trillion mark for the fiscal year as a whole.