Low Inflation Supports Recent Rate Cuts

Very Weak Chicago PMI

Bears are having a field day with the Chicago PMI report because the PMI fell from 47.1 to 43.2. That missed estimates for 48.3 and the low end of the consensus range which is 47.6. A big negative stat being put out is that 8 of 9 times the PMI was this low, the economy was in a recession. You can see in the chart below, earlier this cycle, there was 1 reading below this which obviously didn’t lead to a recession.

While the bears love this report, it’s fairly obvious that there isn’t a recession as few other data points corroborate with it. This is a slowdown. Chicago Fed PMI report was pushed lower than it would have been because of the GM strike. That strike ended in late October which means it still impacted this report. Let’s wait for the November report before even mentioning the possibility of a recession. Investors expect the November PMI to increase at least 3 points.

Personally, I don’t expect this weakness to continue. Specifically, the PMI was the lowest since December 2015. 3 month average fell to 46.9. Even though the index cratered, only 2 of the categories in this report fell. Two weak points were new orders and backlogs. New orders index fell to 37 which was the weakest reading since March 2009. 

It’s clear the economy didn’t plummet that badly in October. 

We have seen relatively positive regional Fed manufacturing reports.

Some people might be confused because the economy is in a slowdown, but a lot of the confusion stems from bias. If you aren’t biased, you know the economy isn’t as bad as it was in March 2009. Another negative was backlogs which fell 13.6 points to 33.1. That’s the 2nd straight below 50 reading. 

Keep in mind, the GM strike started in mid-September which means it negatively impacted last month’s report as well. We can tell this is unusual weakness because the production index increased to 46.8. It probably wouldn’t increase if the economy plummeted. It being below 50 since July signals there has been a slowdown; there's no denying the weakness. 

Inventory index rose to 47.1 which was the highest reading since August. Employment readings spiked 4.2 points to 49.8, meaning employment fell very slightly. Prices paid index fell to 54.8 as steel prices fell, but tariffs boosted prices.

There were 2 interesting special questions. When asked about the recent Fed rate cuts (presumably not the one this week), 51.1% of firms said they would have no impact and 31.1% said they would have a positive impact. Cuts will have a positive impact. This survey measures sentiment. 

If firms think a positive catalyst is coming, they will boost production which helps growth. 56.5% stated tariffs will cause little negative impact on their businesses. And 26% said they will have a major negative impact. Those firms in the latter category will be happy about the progress made on phase 1 of the trade deal.

September PCE Report

September PCE report was very good as yearly consumption and income growth improved and core PCE inflation fell. It was the perfect report in my opinion. Specifically, monthly personal income growth was 0.3% and August’s reading was revised up to 0.5% from 0.4%. It’s nice when a reading meets estimates even though its comp got tougher. Wages and salaries monthly growth was 0%, but that followed 0.6% growth in August.

Yearly, real disposable income growth improved from 3.08% to 3.48%. As you can see from the chart below, it was above real consumption growth again. Consumers are saving much more as the savings rate improved to 8.3% from 8.1%. That’s the highest rate since March 2019. 

If the consumer was to get more confident because of the rise in stocks and phase 1 of the trade deal being made, there could be a huge burst in spending. Also, of the savings rate declines a bit, there could be a big burst in spending during the holiday shopping season. 

It’s great to see real personal income growth increase for the 2nd straight month. It was the best reading since December of last year. 2 year growth stack actually increased slightly because last year growth fell from 4.3% to 3.99%.   

August monthly consumer spending growth was revised from 0.1% to 0.2%. Once again, September’s growth met estimates (of 0.2%) even though the prior month was revised higher. This was a solid reading. Monthly growth in spending on durables was 0.4%. 

Growth was -0.1% for non-durables and 0.2% for services. Headline PCE yearly growth increased from 3.85% to 3.95%. Real yearly consumption spending growth improved to 2.6%. There is room for it to increase even more. 

Core Inflation Falls

Fed has been allowed to cut rates in this slowdown even though the expansion is over 10 years old because of low inflation. Despite the decent wage growth, core inflation has stayed below 2%. Specifically, headline monthly PCE inflation was 0% which met estimates and was the same as last month.

As you can see from the chart below, headline yearly PCE inflation fell from 1.4% to 1.33%. That missed estimates for 1.4%. Core PCE inflation was 0% monthly which missed estimates for 0.1% and August’s 0.1%. Yearly core PCE inflation was 1.67% which fell from 1.77% and met estimates for 1.7% on a rounded basis. 

Fed’s core PCE target is 2%. It has been below 2% since last October. It’s actually a surprise core PCE inflation fell because last year’s comp went from 2% to 2%. No comp change and a yearly growth decline equals a decline in the 2 year growth stack.

Conclusion

Chicago Fed PMI was weak because of the GM strike. September PCE report was actually really good because income growth and spending growth were up. Savings rate increased which means the consumer has dry powder to spend more for the holidays. Core PCE inflation fell, supporting the Fed’s 3 rate cuts this year. 

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