Wealth Bytes: Are we at a cross-roads for the economy??

Wealth Bytes: Are we at a cross-roads for the economy??

July 31, 2023

Growth in Durable Goods

We begin with the US Durable Goods which came in with a month-over-month growth of 4.7%. However, when we take out the transportation sector, which is done for GDP purposes, then we see that growth was a more tepid 0.63% month-over-month growth. For the last 12 months, the average monthly gain for the US Durable Goods excluding transportation has been 0.36%.

Decline in home sales is only slight

Last week, we also received a new reading on new homes sales which declined from the recent high of the prior month. Given the sudden surge in June, it is no surprise that July’s reading would be a little weaker. What is also positive is that the median price only declined a little. This would seem to indicate that home buyers are willing to buy despite the increase in mortgage rates over the last 12 months.

Both PCE & CPI show relatively strong declines in inflation

Last week, we also received a new PCE (Personal Consumption Expenditures) reading on inflation. While the CPI (Consumer Price Index) is perhaps the more well-known reading on inflation, the Federal Reserve prefers the PCE index. However, at the headline level both have shown relatively strong declines primarily with reductions in both food and energy.

Core PCE price index on inflation shows a solid one-month decline

However, the more closely watched number is the core PCE index which is taking a longer path to decline but did have a solid one-month decline to 4.1%. While the one-month decline is desirable, it is still a little more than twice the Fed target of 2%. While the Fed in their set of projections, estimates that core PCE will be about 3.9% by the end of the year, we have seen some estimates as low as 3%.

Inflation in Services remains high

However, inflation in Services is remaining stubbornly high and stable, while the Goods section of the economy is already experiencing some deflation.

With Services being such a large part of our economy, we need to see a decline in services inflation in order to reach the 2% target of the Federal Reserve.

Personal income sees improvement

Real (inflation adjusted) personal income increased 0.18% month over month and 4.75% year over year, which would indicate that households in the aggregate are no longer “treading water” in terms of income and inflation which is also showing up in the increase in personal spending.

Expecting another rate increase for the Fed to stabilize

We also received a reading on the second quarter GDP, which came in at a 2.4% annualized rate with personal consumption and business investment being the strongest contributors. Trade and home building were slight drags.

The Fed increased rates another 25 basis points and very little change to their statement from last month. We would expect another rate increase later in the year and then for the Fed to be stable. We do not expect rate cuts by year-end. The Fed did not update their forward expectations and so, from June, they expect 2023 to have positive GDP growth of about 1%, which would imply zero to slightly negative GDP growth for the rest of year to balance out the year to date growth of about 1.1%.

With growth in both GDP and real income, there is a growing sense among some that we could have a situation in which inflation declines at an acceptable (whatever that means) rate without the Fed having to push us into a recession. This is the so-called soft landing scenario.

While a soft landing scenario is possible, it appears to overly rely on ongoing strength in the labor markets and growth of income. Should inflation not decline at a fast enough rate, or if we encounter a weakening of real income, then we could end up with stagflation in which growth and inflation are essentially balanced (we have used the term treading water).

As we noted, we do expect a “higher for longer” scenario for rates which will mean that companies and consumers will need to watch their balance sheets carefully and be cautious with the use of debt.

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