KEY DATA: CPI: 0.1%; Over-Year: 1.8%; Ex-Food and Energy: 0.1%; Over-Year: 2%/ Real Earnings: 0.2%; Over-Year: 1.3%
IN A NUTSHELL: “Tame inflation is allowing consumer spending power to hold up as earnings growth is slowing.”
WHAT IT MEANS: Is the Fed worried about inflation? Yes. But it is probably because it is too low! The Consumer Price Index barely budged in May and even the modest rise was misleading. Hardly any components posted significant gains while there were quite a few that had negative numbers. Energy costs dropped but food prices rebounded. Essentially a wash there. Used vehicle and medical goods prices declined but medical services were up. The rest largely wandered around. Basically, there is little pressure on consumer costs that you can find in this report.
And it is really good that inflation remains tame, as worker earnings are also going nowhere. Yes, hourly earnings rose at a moderate pace, but the gain over the year has stopped rising. But of real concern is that hours worked is dropping. When you add hours worked to earnings and adjust for inflation, that measure of weekly earnings is running at only about 1%. As I keep saying, it is hard to generate strong consumption spending if workers spending power is modest, at best. And right now, it is extremely modest even given the lack of inflation.
MARKETS AND FED POLICY IMPLICATIONS: The Fed is facing a lot of problems and a key one is that inflation is below target. It is the low inflation that is keeping consumer real income growth from totally falling apart. So, if the Fed tries to get inflation up by cutting rates, it could wind up causing consumption to falter. That could offset the gains from any stronger growth from interest sensitive sectors. If Chair Powell really is signaling that he is going to cut rates, something I think is way too early to even consider, then he better hope that stronger growth does not cause inflation to accelerate. Luckily, even with the unemployment rate below where most Fed members and economists think is full employment, wage gains are not increasing. Firms seem to be willing to leave job openings high rather than pay up to get the workers. Maybe that means a rate cut could encourage more growth without greater inflation. However, to get that, you have to maintain the exceptionally strong productivity growth we have seen recently. Otherwise, you don’t get more output, just lower rates. On the other hand, the last thing the Fed wants to do is raise rates, which could slow growth, slow inflation, slow income gains further and cause investors to throw another tantrum. The Fed is stuck at the current rate and all this talk about a rate cut makes no sense unless the Fed actually sees the economic fundamentals clearly weakening. That could take quite a while to become clear. To paraphrase Laurel and Hardy, “Well, Jay, here’s another nice mess you have gotten us into”.