Road Clears for a Fed Cut in September

by | Aug 19, 2024 | Economic Perspectives

The July inflation data was slightly better than expected, but there was enough there in the details to preclude too jubilant an interpretation. Indeed, the market reaction was very muted. Both overall and core (ex-food and energy) prices increased 0.2% m/m, allowing the two respective measures of inflation to ease one tenth, to 2.9% y/y and 3.2% y/y, respectively. The headline print marked the first sub-3.0% reading since March 2021.

A lot of categories came in softer than anticipated, which introduces the risk of some reversion higher next month. For example, food and energy were quite well behaved, with food prices up a moderate 0.2% m/m and energy flat. Used vehicle prices dropped 2.3% m/m, more than we anticipated given Manheim auction data, and medical services surprised heavily to the downside with a 0.3% m/m decline. The only significant real upside surprise in July came from shelter, specifically rents. Having eased noticeably in June, rent of primary residence unexpectedly jumped 0.488% m/m, the highest three-decimal reading since May 2023. This does not jive with signals from other rent inflation metrics and so, we’ll do what we always think is wise when we get extreme readings in an indicator in consecutive months: take the average. This leaves the gentle downtrend of the past year well in place; if anything, we would not be surprised to see either a downward revision to the July data, or another big step down in August. Given the mix of upside and downside surprises in the July report, and our expectation of some reversion next month, as things stand, we look for a similar 0.2% m/m increase in overall prices in August, which would lower the inflation rate three tenths to 2.6% y/y.

The Fed has everything it needs to deliver a 25 basis point (bp) rate cut in September. But not 50 bp…at least not without a really bad August employment report. Having long advocated for a summer start to rate cuts, we find ourselves in the odd position of pushing back against what now appear to be unwarranted calls for a 50 bp cut in September. It’s not that the macro data do not warrant rates being 50 bp lower than where they are. Rather, having signaled a single 2024 rate cut in the June Summary of Economic Projections (SEP), the Fed would need something more dramatic than what has transpired so far to deliver a jumbo cut in September. Assuming that the data do not force the FOMC’s hand beforehand, we think a 25 bp in September, alongside an updated dot plot showing 3-4 cuts this year is a much more balanced approach.

The value of a gradual approach was reinforced by the much stronger than expected July retail sales report. Admittedly, the details weren’t nearly as robust as the 1.0% m/m jump in total sales would suggest, but this was nonetheless above all expectations and helped alleviate investor fears of an imminent sharp downturn in consumer demand. The truth is likely somewhere in the middle, with the underlying trend in demand likely closer to the 0.3% m/m increase in control sales (excluding food services, building materials, autos dealers and gas stations). Just like in June, there were some big moves across the components, in many cases, in the opposite direction. For example, having declined 3.4% m/m in June, sales of motor-vehicles and parts jumped 3.6% in July. Having declined 1.1% m/m in June, sales of electronics rebounded 1.7% in July. By contrast, after a 1.7% gain in June, “miscellaneous” sales plunged 2.5% in July; while online sales grew a mere 0.2% m/m in July following June’s blockbuster 2.2% surge. Perhaps it is worth paying more attention to the y/y performance, which is far from great. Seasonally adjusted nominal retail sales are only 2.7% higher than in July 2024; given the increase in inflation in the intervening period, this leaves real sales flat to slightly negative y/y.

Housing activity continues to languish. Housing starts declined 6.8% m/m in July, but performance was actually worse than this number suggests because there was a massive plunge in single-family starts (down 14.1% m/m) that compared in magnitude to the experience of March-April 2020. Multi-family starts jumped 14.5%, offering some support. Both segments remain well below-year earlier levels, however, with single family starts down 14.8% y/y and multi-family starts down 18.4% y/y. Meanwhile, building permits more than retraced June’s increase to settle at the lowest level since June 2020.

Homebuilder confidence continues to worsen. The NAHB (National Association of Homebuilders) index ticked down two more points to 39 in August, exactly half its level in August 2020 and the lowest level this year. Buyer traffic and present sales showed further erosion, while sales expectations improved incrementally. The dynamic makes sense: we’ve argued previously that rate cuts may create a bit of an air pocket in housing demand as it incentivizes buyers to wait for lower mortgage rates even as demand deferral may also put some downward pressure on prices.

Industrial production disappointed in July. Not only did output shrink by 0.6% (double the anticipated rate) but there was a meaningful downward revision to the June data centered on manufacturing. As a result, the y/y comparison turned negative again (-0.2% y/y). Sequentially, there was a big pullback in utilities in July that followed three strong back to back increases; mining was flat, and manufacturing output shrank 0.3% m/m.

Consumer sentiment improved modestly in August, according to preliminary readings on the University of Michigan consumer sentiment index. The 1.4-point improvement retraced about 80% of July’ decline and was attributable exclusively to better expectations. Assessments of the current economic situation actually worsened. As to the rise in expectations, the most noticeable uptick was among democratic party supporters, with sentiment among independents up only marginally, and down among republican party supporters. Clearly, President Biden’s decision to not seek re-election has had an impact on consumer sentiment. Elsewhere, inflation expectations were stable. Short-term (1 year) inflation expectations were unchanged at 2.9% and long-term (5-10 year) inflation expectations were unchanged at 3.0%, where they’ve stood since April.

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