Cooler inflation and moderating growth should give Fed some flexibility

Trend watch

Air passenger traffic continued to slow, slipping 3.6% on the week to 18.0 million. That’s down 2.8% compared to the same week a year ago, but the year-to-date is roughly even with last year.

Our take

The latest economic reports point to an economy that is still growing at a healthy, albeit moderate, pace. Most sectors remain resilient, though consumer spending and labor market conditions continue to cool toward more balanced levels.

Consumer inflation remained subdued in July, offering both households and policymakers some relief. The latest inflation data showed that energy prices continued to act as a powerful disinflationary force, helping offset pressures elsewhere in the economy. Transportation services also cooled, reinforcing the trend of easing price growth and suggesting that inflationary momentum remained contained heading into the second half of the year

A similar story emerged further up the supply chain. Wholesale inflation softened again in July as another decline in energy costs weighed on producer prices. The ongoing retreat in energy-related expenses helped ease year-over-year wholesale price pressures, reducing the likelihood that businesses would face significant new cost increases in the near term. For the moment, lower energy prices continue to provide an important buffer against broader inflation risks.

Despite the favorable inflation backdrop, consumer spending showed signs of moderation. Retail sales were held back by weaker purchases of autos, gasoline, and online goods, pointing to a more cautious consumer. While several major categories weakened, spending at restaurants and bars increased, suggesting that consumers remain willing to spend on experiences and discretionary services even as purchases of some big-ticket and goods-related items cooled.

Housing activity also weakened during the month. Existing home sales declined in July, accompanied by a drop in home prices, highlighting the challenges facing the housing market. Affordability pressures, elevated borrowing costs, and limited buyer demand continue to restrain activity, leaving residential real estate as one of the softer areas of the economy.

Meanwhile, consumers grew more pessimistic about the economic outlook. Consumer confidence fell in July, while short-term inflation concerns edged higher despite the recent improvement in headline inflation data. Taken together, the latest reports paint a picture of an economy that is still expanding but losing some momentum. Cooling inflation remains a positive development, but softer spending, weaker housing activity, and declining confidence suggest consumers are becoming increasingly cautious about the road ahead.

Moderating inflation should allow the Federal Reserve (Fed) to maintain a patient approach. Despite markets pricing in a more hawkish policy path recently, we remain solidly in the camp that the Fed will stay on hold over the near term.

However, there’s a lot more data before the Fed meeting on September 16^th, including the three key inflation metrics along with the August jobs report and other supplementary employment data.

July's economic data suggested inflation pressures continued to move in the right direction, aided significantly by lower energy costs at both the consumer and producer levels. However, softer retail spending, weaker housing activity, and a decline in consumer confidence point to a consumer becoming more cautious amid lingering economic uncertainty. While cooling inflation should provide the Federal Reserve with added flexibility, the broader economy appears to be shifting into a slower, more measured pace of growth rather than accelerating into the second half of the year.

Bottom line

Despite crosscurrents, the U.S. economy remains on solid footing, supported by resilient consumer spending and strong technology investment. Meanwhile, business investment remains healthy, while manufacturing appears to be gathering some momentum signaling continued economic expansion. Moderating data and cooler inflation should let the Fed stay on hold, though the recent resurgence in gasoline prices poses an upside risk. Still, our view stands that the bar remains high for a Fed rate hike this year.