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How to Think about Inflation

How to Think about Inflation

| August 29, 2022
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Real Spending Grew in July

Real personal spending rose 0.2% in July, a positive indicator for Q3 economic growth. However, consumers need to see a higher growth rate in personal incomes for the real economy to grow in Q3. Personal income also grew in July, but was only up 4.6% from a year ago, not quite keeping up with the pace of inflation as the Personal Consumption Expenditure (PCE) deflator was up 6.3% from a year ago.

“Overall, July was a good month for real spending but consumers have two more months to go,” explained LPL Chief Economist Jeffrey Roach. “Investors may get ahead of themselves if they think growth is a foregone conclusion this quarter.” The economy is on a stabilizing trajectory so the domestic economy could still eke out positive economic growth this year.

The July savings rate was 5%, unchanged from the previous month. The stock of savings is still high and continues to buffer consumers from ongoing inflation pressures. Checkable deposits for both households and nonprofit organizations are over $4 trillion as of Q1. However, the longer inflation erodes wages and earnings, consumers must tap into savings or credit to support recent buying habits.

Inflation Decelerates

As shown in the LPL Chart of the Day, this latest report validates the view that the economy is likely past peak inflation as the yearly pace of inflation in July decelerated for both total inflation and core inflation.

For the first time in a while, yearly inflation rates eased for durable goods, nondurable goods, and services. Not all subcategories improved: food prices continue to accelerate. For some demographics, the pain from a quickening pace of food inflation will be particularly acute.

View enlarged chart. 

Base effects will have a larger impact in the coming months, but clearly inflation rates are cooling as supply and demand imbalances are improving. One variable we highlighted several months ago is the New York Federal Reserve’s supply chain pressure gauge. As supply bottlenecks improved in recent months, we expected inflation metrics would eventually ease as transportation and logistics companies worked through global supply constraints and consumers are finally seeing the first-fruits of better supply chains. Looking ahead, inflation will likely cool throughout the remainder of this year.

Maybe a Sigh of Relief from the Fed?

Our view is that a sigh of relief is premature but at least inflation rates are decelerating. As Federal Open Market (FOMC) committee members say, there’s more work to be done. Total services inflation also decelerated in July but driven by public transportation prices. Rental prices, which affect over 30% of the U.S., accelerated to 6.3% from a year ago.

Chairman Powell and his colleagues will likely highlight the risks from inflation pressures that are large in both magnitude and in duration. And in his Jackson Hole remarks, Powell played tough and not-so-sweet. In a speech of just 1,300 words, Powell says “price stability” nine times and he built the case that a strong labor market is predicated on price stability. In essence, Powell is clearly stating that, right now, fighting inflation is more important than supporting growth. One glimmer of hope from the Chair’s comments is his view that inflation expectations appear well-anchored. Supply constraints are still an important factor in understanding the current inflationary environment and is a key to the timing for slowing the pace of rate increases.

Since monetary policy decisions take time to impact the real economy, we may not yet have the full impact of the previous front-loaded rate hikes from June and July. However, the latest inflation report supports the view that the Federal Open Market Committee (FOMC) could slow the pace of tightening in the upcoming meetings.

 

IMPORTANT DISCLOSURES

This material is for general information only and is not intended to provide specific advice or recommendations for any individual. There is no assurance that the views or strategies discussed are suitable for all investors. To determine which investment(s) may be appropriate for you, please consult your financial professional prior to investing.

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