KEY DATA: CPI: +0.1%; Over-Year: +1.6%; Ex-Food and Energy: +0.3%; Over-Year: +2.1%/ Hourly Earnings: +0.2%; Over-Year: +1.5%/ Claims: down 13,000
IN A NUTSHELL: “The tight labor market is not causing wages to surge, so inflation remains lower than expected.”
WHAT IT MEANS: Yesterday Fed Chair Powell signaled that rates would be coming down, probably at the end of the month. So we have almost three weeks to see if his fears about weak inflation and a slowing economy are founded. On the inflation front, his worst concerns were not matched by the June Consumer Price Index report. Costs rose modestly, but that was largely due to the more volatile food and energy components, which were flat or down. Excluding those elements, prices rose at the fastest pace in over a year. Costs of shelter and medical care, not surprisingly, are driving up the index. In June, though, the biggest increases were in used vehicles and clothing. I am not sure those two will play a major role going forward.
The number of new claims for unemployment insurance fell sharply last week and you would think that move signals further tightening in the labor market. It probably does, but that doesn’t seem to be doing much for wages. Hourly wages, adjusted for inflation, rose moderately in June. Over the year, they have increased by a pace, 1.5%, that can hardly be described as strong. And if the Fed gets inflation to accelerate, spending power could rise even less.
MARKETS AND FED POLICY IMPLICATIONS: Yesterday, Mr. Powell sent clear signs that he was worried about the economy and would be willing to lower interest rates. Unfortunately, his logic is flawed. A major concern is trade, which is slowing world growth. Under normal circumstances, lower interest rates might be expected to increase growth, but that doesn’t seem likely right now. First, cutting rates would not change the factors that are harming world growth. They are tariffs and the fears of a further expansion in the trade war with China. Lowering rates does not change those concerns or reduce the costs of tariffs. So, why would businesses change their investment or expansion plans? Got me. Meanwhile, the interest sensitive sectors, such as housing and vehicles, are not likely to be helped much by a quarter or half point cut. Rates are already low and it isn’t the cost of funds that are restraining the markets. So what the Fed Chair expects to accomplish is beyond me. But he persists. On the inflation front, the Consumer Price Index, which is not the favored inflation measure but one that is watched nonetheless, is not showing major problems. Other, less volatile measures created by the Cleveland and Atlanta Fed Banks show inflation at an even higher rate. But he persists. I am guessing that Mr. Powell is counting on a sub-2% second quarter GDP growth rate to bolster his position. And that is quite possible. But one thing we know about GDP reports, they often surprise. So, what does he do if a 2.5% growth rate prints? That would hardly argue that the economy is currently being greatly affected by the trade issues. The Fed Chair is on shaky grounds and while we are likely to get a rate cut at the end of the month, it would be nice if Fed policy was not being based so much on guesses and issues, such as trade policy, that monetary policy cannot influence.