Finding the Balance

Look out below

Consumer prices increased 1.8% for the twelve months ending in July, slightly higher than the 1.6% increase last month but still significantly lower than the 2.9% readings last year. Excluding food and energy, core CPI actually increased 2.2% over the last year, which the highest reading in six months. While this measure of inflation is trending close to the Fed’s 2% target, the Fed’s preferred inflation tracker (PCE Index) is running close to 1.4%. 

Moral of the story: These inflation levels still provide the Fed with an option to further cut rates in 2019 if they perceive the economic conditions warrant such action – the market is actually expecting a 100% chance of another rate cut. On a related note, the 2-yr and 10-yr treasury yield curve inverted for the first time this week since June 2007 as worries of a global slowdown sent investors to long-term US government bonds, which are considered a “safe” investment (as demand for bonds increases, the yield required to compensate investors falls). Yield curve inversions tend to be predictors of recessions and the Fed could correct the inversion by reducing the short-term interest rates. Finding the right balance between economic stimulus and forced recession will be the Fed’s job in the upcoming months. 

Just keep buying

Retail sales increased by 0.7% last month, coming in much higher than expectations. Internet retail sales jumped 2.8% (probably driven by Amazon Prime Day) but sales also increased across the board at department stores (this one is a surprise), restaurants, and electronic outlet stores. Amazon Prime Day actually also had a similar impact on retail sales in the UK. 

Moral of the story: Strong consumer spending is currently enabled by the healthy labor market. The worry is the impact of the China trade war. If it impacts prices of goods or corporate profits such that the labor market weakens as companies rationalize costs, it will impact consumer spending and, in turn, economic growth. 

Houston, we may have a problem 

Consumer sentiment fell sharply from 98.4 last month to 92.1 in July, marking the lowest reading so far this year. Components of the index – how consumers view their financial situation, the health of the economy, and their expectations for the upcoming six months – fell to two-year lows.

Moral of the story: The escalation in the China trade war and the Fed’s recent commentary on a weaker economic outlook have spooked consumers. If consumer sentiment continues to worsen, it could prompt consumers to increasing savings to prepare for an uncertain future. Higher savings means lower spending. See above for the implications of lower consumer spending.

I’ll be taking a short break next week as I hike my way through Iceland – but I promise some beautiful pictures and stories the following week!