Core PCE Reverses Course in August, Pushing Higher to 2.7% after Moving Sideways in July

This morning, the PCE rose 0.1% in August, as expected and following a 0.2% gain in July. Year-over-year, headline inflation increased 2.2%, a tenth of a percentage point below expectations and down from the 2.5% annual increase in July.

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Excluding food and energy, the core PCE rose 0.1% in August, lower than the 0.2% gain expected and following a 0.2% increase in July. Over the past 12 months, core inflation increased 2.7%, as expected and an uptick from the 2.6% annual gain in July. August’s 2.7% annual gain marks a three-month high.

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The supercore PCE measure – core services excluding shelter – rose 0.2% in August and increased 3.3% on an annual basis, an uptick from the 3.2% gain in July and a two-month high.

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Bottom Line: A somewhat mixed inflation report this morning is likely to intensify the already present divide among policy officials.?While the headline offered further confidence in the disinflationary trend and support for the Fed's larger 50bp cut last week, a tick higher on the core after one month of sideways movement coupled with a lack of further improvement in the core CPI and core PPI last month suggests there remain upside inflationary risks.?

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Taken alone, this morning’s report – and the headline improvement – is enough to justify a further 25bp cut in November now just six weeks away. Although, another month of questionable inflation data and/or a stronger-than-expected employment report next Friday could embolden the more hawkish members.?

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As Chair Powell noted during the press conference in September, the Fed is in no rush to cut rates and furthermore 50bp moves should not be seen as the new normal pace. As always the Fed, he reiterated, will remain data dependent and is not on a pre-determined pathway.??

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Also this morning, personal income and consumption were slightly weaker in August, not unexpected however given yesterday’s GDP release showing still a solid pace of expenditures.??

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Personal income rose 0.2% in August, half of the 0.4% rise expected and following a 0.3% increase in July. Consumer spending, meanwhile, increased 0.2% in August, a tenth of a percentage point less than expected and down from the 0.5% rise the month prior. Year-over-year, consumer spending increased 5.2%, a four-month low, while personal income rose 5.6% in August, an eight-month low.

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Adjusting for inflation, real consumer spending rose 0.1%, as expected, and real income also gained 0.1%?in August for the third consecutive month. Over the past 12 months, real spending rose 2.9%, up from the 2.8% annual gain in July, and real disposable personal income gained 3.3% in August for the fourth consecutive month.

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Yesterday, GDP was unrevised at a 3.0% gain on an annualized basis in the final Q2 report, as expected and marking the largest gain in two quarters. The four-quarter average rose from 2.9% in Q1 to 3.0% in Q2.

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In the details of the report, personal consumption was revised slightly lower from a 2.9% rise to a 2.8% gain in the third-round Q2 report, still the largest increase in two quarters.

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Goods consumption was unrevised at a 3.0% increase in the final Q2 report, due to an upward revision in durables consumption from a 4.9% gain to a 5.5% rise, and a downward revision to nondurables consumption from a 2.0% gain to a 1.7% rise.

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Services consumption, meanwhile, was revised down from a 2.9% increase to a 2.7% rise, a three-quarter low.

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On the other hand, gross private investment – a gauge of business spending – was revised up from a 7.5% rise to an 8.3% gain, the largest quarterly increase since Q3 2023.

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Fixed investment was revised down from a 3.0% rise to a smaller 2.3% gain in the final Q2 report, the weakest quarterly pace since Q4 2022.

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Nonresidential investment – including office buildings and factories – was revised down from a 4.6% increase to a 3.9% gain, due to downward revisions in equipment investment from a 10.8% rise to a 9.8% gain, and intellectual property investment from a 2.6% gain to a 0.7% increase. Structures investment, on the other hand, was revised up from a 1.6% drop to a 0.2% rise in the third-round Q2 report, albeit still the weakest quarterly pace since Q4 2021.

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Residential investment, meanwhile, was revised down from a 2.0% decline to a 2.8% drop, marking the largest quarterly decline in five quarters.

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On the trade side, exports were revised down from a 1.6% gain to a 1.0% increase, while imports were revised up from a 7.0% gain to a 7.6% rise in the third-round Q2 report, the largest gain since Q1 2022.

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Finally, government consumption was revised up from a 2.7% gain to a 3.1% increase. Federal spending was revised up from +3.3% to +4.3%, with national defense spending revised higher from +4.9% to +6.4%, and nondefense spending was revised up from +1.2% to +1.5%. State and local spending, meanwhile, was unrevised at a 2.3% increase, the weakest pace in two years.

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In addition, the Core PCE Price Index was unrevised at a 2.8% gain in the final Q2 report, the weakest gain in two quarters.

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Bottom Line: A solid showing, at least in the rear-view mirror, of domestic?activity reinforces the need for a tempered?and patient approach to subsequent?rate reductions. With no indications of a downturn or mounting?weakness ahead, despite modest cooling in some reads on labor market momentum, the focus appears to be still on the lingering challenge?of returning?prices to a sustainable?2% level. While normalizing?conditions?do warrant?a less firm approach to policy?and a continuation?of rate reductions, a lack of meaningful?ongoing?disinflation supports?a base case of smaller 25bp cuts with a?consideration, but not a commitment?to action at every upcoming meeting.

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Also yesterday, durable goods orders were unexpectedly flat (0.0%) in August, following a 9.9% jump in July. According to the median forecast, durable goods orders were expected to drop 2.6%. Year-over-year, headline orders rose 1.5% in August, the largest annual gain in six months.

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Transportation orders fell 0.8% following a 34.7% increase the month prior. Excluding transportation, durable goods orders rose 0.5% in August and increased 1.0% over the past 12 months, up from the 0.7% annual gain the month prior.

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Capital goods orders fell 0.4% in August following a 34.7% rise the month prior. Nondefense capital goods orders, meanwhile, declined 1.3% following a 42.1% rise in July. Capital goods orders excluding aircraft and defense – a proxy for business investment – rose 0.2% in August, the strongest pace in two months. Year-over-year, however, business investment declined 0.1%, down from the 0.6% annual increase in July.

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In other details, fabricated metals orders climbed 0.6%, machinery orders gained 0.5%, and electrical equipment orders increased 1.9%. Also, primary metals orders rose 0.2%, and computers and electronics orders increased 0.4%.

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Additionally yesterday, initial jobless claims fell from 222k to 218k in the week ending September 21, the lowest level in four months. The four-week average, meanwhile, declined from 228k to 225k. Continuing claims, or the total number of people claiming ongoing unemployment benefits, rose from 1.82M to 1.83M in the week ending September 14.

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On the housing front, pending home sales rose 0.6% in August, slightly less than the 1.0% gain expected. On an annual basis, pending home sales fell 4.3%, a slight uptick from the 4.6% annual drop in July.

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Finally, yesterday, the Kansas City Fed Manufacturing Activity Index fell five points to a reading of -8 in September, the lowest reading in two months. According to the median forecast, the index was expected to decline to -5. In the details of the report, the volume of new orders fell two points to -14, and the number of employees declined from -7 to -11 in September, the lowest reading in two months. Also, shipments dropped 11 points to -12, and prices paid declined from +18 to +13, a three-month low.

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Also this morning, wholesale inventories rose 0.2% in August, as expected and following a 0.3% gain the month prior.

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Finally, this morning, the final University of Michigan Consumer Sentiment Index for September was revised up from 69.0 to 70.1, a five-month high. In the details of the report, a gauge of current conditions was revised up from 62.9 to 63.3, and a gauge of future expectations was revised higher from 73.0 to 74.4 in the final September print, the highest reading in five months.

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Next week, the economic calendar begins Monday with the Dallas Fed Manufacturing Activity Index, and with the Chicago PMI.

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On Tuesday, the final S&P Global U.S. Manufacturing PMI will be released, along with construction spending, the August JOLTS report – or Job Openings and Labor Turnover Survey , and the ISM Manufacturing Index for September.

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In August, manufacturing activity rose 0.4 points to a reading of 47.2 in August. Despite the monthly uptick, however, this marks the fifth consecutive month in contractionary territory, or a reading below 50. In September, the ISM Manufacturing Index is expected to rise, albeit still remain in contractionary territory at a potential reading of 47.5.

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Later in the week, on Wednesday, weekly mortgage applications, followed by the September ADP employment report.

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On Thursday, weekly jobless claims, the final September print of the S&P Global U.S. Services and Composite PMIs, along with factory orders for August, durable goods orders, and the August ISM Services Index.

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Like the ISM Manufacturing Index, the ISM Services Index unexpectedly ticked up in August, albeit minimally by one tenth of a point to a reading of 51.5, the highest reading since May. This month, the services index is expected to remain unchanged at 51.5 in September for a second consecutive month.

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On Friday, we come to the key release of the week – the September nonfarm payrolls report. After a smaller-than-expected gain of 142k in August, nonfarm payrolls are expected to rise 130k in September, potentially marking a two-month low. Although the gain would potentially boost the three-month average, from 116k to 120k, a two-month high.

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The unemployment rate, meanwhile, is expected to remain steady 4.2% for the second consecutive month, still well below what the Fed designates as the full unemployment range, and perpetuating the notion of ongoing tight-ish labor market conditions.

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Average hourly earnings are expected to rise 0.3% in September, following a 0.4% gain in August, potentially resulting in a 3.7% increase over the past 12 months, down from the 3.8% annual increase in August. ?

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With a growing focus on potential weakness in the labor market, a weaker-than-expected read in Friday’s report will no doubt boost expectations for a more sizable Fed response come November. Equally, however, further indications of an ongoing solid or steady labor market coupled with still elevated prices will serve to underscore the need for a more tempered and patient approach to rate cuts going forward.?

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Finally, on the Fed-speak front, we will again hear from a number of Fed officials including Chair Powell himself on Monday, Bostic and Cook on Tuesday, and Cleveland’s Beth Hammack (who took the place of Loretta Mester last month). Also next week, on Wednesday, St. Louis Fed President Alberto Musalem with take the stage along with Governor Bowman. Finally, on Thursday, we’ll hear from Minneapolis Fed President Neel Kashkari.?

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Already the array of Fed chatter throughout this week and mixed messaging is further muddying the waters, underscoring the uncertainty in the Fed’s pathway forward and the lack of consensus among officials amid ongoing uncertainty as the data continue to evolve.?

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-Lindsey Piegza, Ph.D., Chief Economist