This morning, data for the Fed’s preferred inflation indicator, Personal Consumption Expenditures (PCE) for July, was released. There were really no surprises in the numbers. The most important number for core PCE, where the volatile food and energy sectors are stripped out, came in exactly as expected at an annual rate of 4.2%. That is below the high for this period of inflation that was hit last year but is still more than double the Fed’s stated 2% target and is an increase on the 4.1% print for June.
Add in an increase in spending and a small increase in income, and this report reinforces what most people already believed about the state of the economy: Inflation is lower than it was, but remains stubbornly above 4%, while consumers are continuing to spend, even though incomes aren’t keeping up with those increases. So, what does this all mean for investors and for the stock market?
The initial market reaction reflected the data themselves. Index futures, such as the S&P 500 E-Mini contract shown above, bounced higher at first but then quickly gave up those gains and returned to a level very slightly lower than they were immediately before the 8:30 AM release. Bonds reacted similarly, with the 10-Year yield dropping slightly at first to take them below 4.1%, then bouncing back to a pretty neutral level. That may make you think that this release was essentially a non-event, but that isn’t the case.
In terms of how the market will react over time, all economic data and news has to be judged primarily on how it reads relative to expectations, and on that basis, this is not an encouraging report. Yes, the actual numbers came in as expected, but overall expectations about what the Fed will do next, the thing that has been driving the stock market for some time now, have driven a strong rally since the beginning of this year. In that context, this is not exactly encouraging data.
As I pointed out earlier this month, strength in consumer spending without commensurate increases in incomes, which this report shows is continuing apace, is a ticking time bomb. It signals growing consumer debt, leaving the economy much more vulnerable to even a mild shock. The problem is that there is a better chance of that now than there was yesterday. The market's recent gains have been driven by the assumption that the Fed will take a much more dovish approach from here on out, but this report makes that much less likely than it was. One should never read too much into a single month’s data on anything, of course, but how can Jay Powell, having said that the data will guide the FOMC, not raise rates when core PCE is higher month-on-month and still more than double his target level?
If he does so, servicing the credit card and other debt that consumers are piling up becomes much harder and a pullback in terms of growth, possibly quite a sharp one, will follow.
This is a case where no news is bad news. What the PCE report showed this morning is that inflation is still a problem, but it is a problem that consumers are doing their best to ignore, spending more even as inflation adjusted incomes fall. That can boost the market for a while but will serve to make it all the more painful when the reckoning comes, as it must at some point.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.
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Martin Tillier
Martin Tillier spent years working in the Foreign Exchange market, which required an in-depth understanding of both the world’s markets and psychology and techniques of traders. In 2002, Martin left the markets, moved to the U.S., and opened a successful wine store, but the lure of the financial world proved too strong, leading Martin to join a major firm as financial advisor.
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