US INFLATION STAYS HOT AS CONSUMER MOMENTUM FADES💥

Yesterday, markets received another important set of US data covering income, spending and inflation — a key input ahead of the Federal Reserve’s September meeting, when policymakers will once again decide on interest rates.

The US consumer lost considerable momentum in July. For the first time in many months, real consumer spending per capita showed virtually no monthly growth, while the annual rate slowed to 1.9% YoY. The most noticeable weakness was concentrated in goods, particularly electronics, motor vehicles and petrol. Spending on services, however, continued to increase, meaning it would still be premature to describe the situation as a broad collapse in domestic demand.

The income picture looks somewhat better, although there are important qualifications. Real disposable income per capita increased by 0.3% MoM and only 0.2% YoY. A significant proportion of July’s improvement came not from stronger earned income, but from government transfers and lower taxation. Net government transfers now account for 7.2% of disposable income, highlighting the considerable role that fiscal support continues to play in sustaining the US consumer.

The savings rate edged higher to 3% of disposable income. While this represents a modest improvement, the level remains exceptionally low. In practical terms, US households have only a limited cushion of available cash savings, reducing their ability to maintain consumption for an extended period by drawing on accumulated reserves.

The inflation component of the report is considerably less encouraging. Consumer prices increased by 0.2% MoM and 3.7% YoY in July, while Core PCE inflation came in at 0.2% MoM and 3.3% YoY. Inflation therefore remains materially above the Federal Reserve’s target, with little convincing evidence so far that price growth is rapidly returning towards 2%.

The composition of inflation is particularly important. Prices for goods excluding food and energy are rising by 2.3% YoY, significantly above their longer-term rate of increase. A sharp rise in electronics prices has contributed to this pressure and has simultaneously weakened demand in the sector. More broadly, however, the effects of Trump’s protectionist policies and tariffs are increasingly being reflected in final consumer prices.

The services sector presents an even greater challenge. Services excluding energy and housing are rising by 3.9% YoY — the measure Powell traditionally watched particularly closely when assessing underlying domestic inflation. Housing costs are increasing by 3.2% YoY, with price growth beginning to accelerate again. Goods inflation also remains elevated, while developments in fuel and food prices provide relatively little additional cause for optimism.

The picture is somewhat more favorable according to an inflation measure preferred by Warsh. Trimmed Mean PCE currently stands at 2.3% YoY, considerably closer to the Federal Reserve’s target. There is, however, an important qualification: the calculation effectively excludes around half of the consumer basket, so it would be premature to treat this measure as evidence that the inflation problem has been resolved.

The Federal Reserve is therefore facing an increasingly uncomfortable combination: consumer demand is gradually cooling, real income growth remains weak, while inflation continues to run at elevated levels. This is precisely the type of environment in which it becomes increasingly difficult for a central bank to support economic activity while simultaneously returning inflation to target.

It is becoming difficult to describe current Federal Reserve policy as genuinely restrictive; if anything, the stance is gradually becoming more accommodative despite persistent inflationary pressure. The most likely approach for now is to wait and assess further incoming data. Warsh, meanwhile, has so far appeared more hawkish in his rhetoric than in his actions, while the first months of his leadership have arguably weakened rather than strengthened market confidence in the consistency of Fed policy.

This makes the September meeting particularly important for reasons extending beyond the rate decision itself. The key issue may be the growing divergence of views within the Federal Reserve. With headline inflation at 3.7%, Core PCE at 3.3%, and services excluding housing and energy running at 3.9%, policymakers favoring a more restrictive stance have increasingly strong arguments. If the number of hawks does indeed increase, markets could receive a considerably more important signal than another 25-basis-point adjustment in the policy rate.

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