Core Inflation Low Enough For Fed Rate Cuts

Core Inflation Low - Beyond Meat Clarification

Before getting into Core Inflation Low - I want to quickly clarify the facts on the Beyond Meat secondary. New capital raised represents 0.4% of equity. Decline the secondary caused the stock to have could be good news. It could get rid of the post-IPO squeeze. The management team doesn’t want the stock to keep going up infinitely. Mostly because larger the rally, the bigger the decline.

Therefore, this decline is healthy. Fact that a small secondary is causing such an issue shows how much of a bubble the stock was in. Deal will price at a discount to Wednesday’s close. Difference between wherever the stock would have been post earnings (probably up slightly) and the price of the discount after Wednesday’s close is the cost of capital.

Dallas Fed Index Improves, But Is Still the Worst of The Bunch

Core Inflation Low - Dallas Fed manufacturing index showed improvement in July. Production index was up from 8.9 to 9.3 and the general activity index was up from -12.1 to -6.3. That missed estimates for -3.5 and the low end of the estimate range which was -6.

As you can see from the chart below, the 3 month moving average of the Dallas Fed index is the worst of the 5 as it is -7.9. Second worst is the Richmond Fed index which is -1.3. Average is 1.8.

After the promising Empire Fed and Philly Fed indexes, the results have been poor. I don’t expect an improvement in the ISM manufacturing index which comes out this Thursday. June reading was 51.7. And the July reading is expected to be 51.9. I expect it to be from 49 to 50.5. My high end is the low end of expectations.  

Core Inflation Low - This wasn’t a disastrous report in rate of change terms like the Richmond Fed one.

Let’s get into the details of the report. New orders index was up 1.8 points to 5.5. Growth rate of orders index was up 9.4 points to 2.7. Shipments index was up 8.5 points to 10.2. Capex index increased 8.3 points to 15.2.

Further good news is the outlook index increased and the uncertainty index decreased. Those go hand in hand. Outlook index was up 4.6 points to -0.9 and the uncertainty index fell 11.9 points to 9.7.

6 month expectations index also showed solid improvement. Production index was up 6.7 points to 31.9. New orders index was up 9.5 points to 31.8. Growth rate of orders and shipments indexes were up 13.5 and 11.5 points to 30.7 and 39.9. Finally, the outlook and general business activity indexes were up 5.5 and 8.7 points to 9.1 and 6.

There were more mentions of tariffs and trade tensions in this report than in the Kansas City Fed report.

Core Inflation Low - Out of the 16 quotes, there were 3 mentions of the trade war. A transportation equipment manufacturing firm stated, “The biggest risk is the Trump administration's tariffs on European Union imports. If implemented, and depending on scope and values, the tariffs could have from a manageable to a dramatic impact.”

I think the latest polls showing Trump behind Joe Biden by an average of 8.1 points will motivate Trump to make a trade deal with China. And it will also stop him from starting any new scuffles.

Another Relatively Weak Redbook Same Store Sales Report

Core Inflation Low - On an absolute basis, the Redbook same store sales growth readings have all been strong in 2019, but compared to the results in the past few months, the readings in the past 3 weeks have been weak.

In the week of July 27th, the final week of the month, same store sales growth fell from 4.9% to 4.5%. After the big burst of 6.2% in the first week of the month, growth has had a 4 handle. It’s possible retail sales growth will be strong.

Even though the month to date Redbook growth average has declined. I expect slight declines in the yearly growth rates because the June reading was so strong. The July retail sales report comes out on Thursday, August 15th.

Core Inflation Low - Income Growth Now Above Spending Growth

Income growth was revised higher. This explains why the savings rate was pushed higher as I discussed in a previous article. Compensation growth may have been driven by employees exercising stock options.

As you can see from the chart below, unlike the 2015-2016 slowdown, income growth isn’t below consumption growth.

Specifically, June monthly income growth was 0.4% which beat estimates for 0.3%. Monthly wages and salaries growth was 0.5% which on top of 0.2%.

Yearly real disposable income growth was 3.3%. May’s reading was revised down from 0.5% to 0.4%. Savings rate increased in June from 8% to 8.1%.

Cycle trough was 4.9%. Monthly consumer spending growth was 0.3% which matched estimates for 0.3%. Yearly real consumption growth was 2.5%. May’s reading was revised higher from 0.4% to 0.5%.

Core Inflation Low - Inflation Stays Low Enough For Rate Cuts

Inflation stayed low in June. Low inflation is letting the Fed to cut rates on Wednesday and possibly again in September. Headline monthly inflation was 0.1% which matched estimates; core monthly inflation was 0.2% which also matched estimates.

As you can see from the chart below, core PCE inflation was 1.6% which missed estimates for 1.7%, but increased from 1.5%. Last June, core CPI was 2%. Recent cycle peak was 2.1% in July.

After that, we have the chance to see core inflation increase which could cause the Fed concern. Very easy comps start next March. Headline PCE inflation was 1.4% which missed estimates for 1.5% and was the same as May’s reading.  

Core Inflation Low - Conclusion

Fed was going to cut rates regardless of what the core PCE inflation rate was. However, it’s still good to see it solidly below 2%. Not that there was any chance of it being above 2%.

Core PCE rarely misses/beats estimates significantly. I’m interested to see what happens when core PCE starts to spike early next year as the comps get easier. I could see near 2% core PCE in Q1.

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  • Thomas Toedtman

    July 31, 2019

    The Dallas region- seems it would include a very large O&G component.
    Probably the dominant influence
    I wonder if Oklahoma is with St. Louis or Dallas?
    Many areas suffered late planting though mostly well north of central Tx.although
    crops can't compare to O&G.

  • Thomas Toedtman

    July 31, 2019

    I'd enjoy seeing a breakdown of the "wage data" to see who is included?
    How tilted are the gains by income? not complaining, just sayin':
    There is data saying wage growth for middle class and down has not significantly improved in decades- but c-suite wages sure have.
    That bit of extra income showing is probably paying down debt, (already spend it).
    Small avocados just went from $.68 to $1.68 overnight! (Mexico/ tariffs ?)

    Thanks for all you do,