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Consumers and Businesses Show Caution

RFP
Personal disposable income rose 0.4% after adjusting for inflation in August. That marks a sharp acceleration after a slowdown in July and suggest that consumers still have the means if not as much willingness to spend. The saving rate reached 8.1% while consumer spending rose only 0.1% after adjusting for inflation, which flatlined with a drop in energy prices offsetting a mild acceleration in core (non food and energy) prices. The overall index for Personal Consumption and Expenditures (PCE) held at a tepid 1.4% on a year-over-year basis while core PCE inflation edged up 1.8% on a year-over-year basis.

The Federal Reserve targets the PCE index at 2%. The core PCE is considered the best predictor of future inflation. Many at the Fed will welcome the warming trend we have seen in the core PCE; it hit a low of 1.5% on a year-over-year basis in May and has moved up consecutively ever since. This has left the Federal Open Market Committee (FOMC) split between those who are willing to wait and see if inflation picks up further before cutting rates again and a minority of two who believe it needs to cut aggressively to trigger a more substantial and sustained rise in both wages and inflation.

Consumer spending was more of a disappointment over the month as consumers pulled back on discretionary services. Consumers were less willing to kick up their heels to spend on food and accommodation or vacations in August. This is consistent with the Fed’s Beige Book report, which reported consumers spending less on tourism and staying in budget hotels more than they had in the recent past. Consumer confidence fell again in September as the trade tensions with China flared. The consumer has recently proven to be more skittish and subject to negative news events.

Separately, durable goods orders edged up 0.2% in August, which was better than expected. Much of that increase may be attributed to a surge in defense orders, which will slow once we get into the new fiscal year on October 1. The largest drop occurred in aircraft orders, which have long lags and continue to be affected by the grounding of the 737 Max at Boeing. Core durable goods orders (excluding defense and aircraft) fell 0.2% in August, after flatlining in July.

Core shipments, which more closely track actual business investment, rose 0.4% in August. Those gains follow a 0.6% drop in July and suggest that overall business investment is still extremely weak in the third quarter. A contraction in mining and the trade war are taking a toll.

Bottom Line
The consumer and businesses both showed a bit of skittishness in August. Consumer spending will remain a driver of overall growth, but is not the Atlas it was in the second quarter. Psychology matters as much as fundamentals; the escalation of tariffs sent a chill before they even took effect. The overall economy is now growing at about a 1.7% pace, a slowdown from the 2% pace we saw in the second quarter.

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