Core Inflation Low Enough For Fed Rate Cuts

Beyond Meat Clarification

I want to quickly clarify the facts on the Beyond Meat secondary. The new capital raised represents 0.4% of equity. The decline the secondary caused the stock to have could be good news as it could get rid of the post-IPO squeeze. The management team doesn’t want the stock to keep going up infinitely because the larger the rally, the bigger the decline. Therefore, this decline is healthy. The fact that a small secondary is causing such an issue shows how much of a bubble the stock was in. The deal will price at a discount to Wednesday’s close. The difference between wherever the stock would have been post earnings (probably up slightly) and the price of the discount after Wednesday’s close is the cost of capital.

Dallas Fed Index Improves, But Is Still the Worst of The Bunch

The Dallas Fed manufacturing index showed improvement in July. The production index was up from 8.9 to 9.3 and the general activity index was up from -12.1 to -6.3. That missed estimates for -3.5 and the low end of the estimate range which was -6.

As you can see from the chart below, the 3 month moving average of the Dallas Fed index is the worst of the 5 as it is -7.9. The second worst is the Richmond Fed index which is -1.3. The average is 1.8. After the promising Empire Fed and Philly Fed indexes, the results have been poor. I don’t expect an improvement in the ISM manufacturing index which comes out this Thursday. The June reading was 51.7 and the July reading is expected to be 51.9. I expect it to be from 49 to 50.5. My high end is the low end of expectations.  

(Click on image to enlarge)

To be clear, this wasn’t a disastrous report in rate of change terms like the Richmond Fed one. Let’s get into the details of the report. The new orders index was up 1.8 points to 5.5. The growth rate of orders index was up 9.4 points to 2.7. The shipments index was up 8.5 points to 10.2. The capex index increased 8.3 points to 15.2. Further good news is the outlook index increased and the uncertainty index decreased. Those go hand in hand. The outlook index was up 4.6 points to -0.9 and the uncertainty index fell 11.9 points to 9.7.

The 6 month expectations index also showed solid improvement. The production index was up 6.7 points to 31.9 and the new orders index was up 9.5 points to 31.8. The growth rate of orders and shipments indexes were up 13.5 and 11.5 points to 30.7 and 39.9. Finally, the outlook and general business activity indexes were up 5.5 and 8.7 points to 9.1 and 6.

There were more mentions of tariffs and trade tensions in this report than in the Kansas City Fed report. Out of the 16 quotes, there were 3 mentions of the trade war. A transportation equipment manufacturing firm stated, “The biggest risk is the Trump administration's tariffs on European Union imports. If implemented, and depending on scope and values, the tariffs could have from a manageable to a dramatic impact.” I think the latest polls showing Trump behind Joe Biden by an average of 8.1 points will motivate Trump to make a trade deal with China and stop him from starting any new scuffles.

Another Relatively Weak Redbook Same Store Sales Report

On an absolute basis, the Redbook same store sales growth readings have all been strong in 2019, but compared to the results in the past few months, the readings in the past 3 weeks have been weak. In the week of July 27th, the final week of the month, same store sales growth fell from 4.9% to 4.5%. After the big burst of 6.2% in the first week of the month, growth has had a 4 handle. It’s possible retail sales growth will be strong even though the month to date Redbook growth average has declined. I expect slight declines in the yearly growth rates because the June reading was so strong. The July retail sales report comes out on Thursday, August 15th.

Income Growth Now Above Spending Growth

Income growth was revised higher. This explains why the savings rate was pushed higher as I discussed in a previous article. Compensation growth may have been driven by employees exercising stock options. As you can see from the chart below, unlike the 2015-2016 slowdown, income growth isn’t below consumption growth.

(Click on image to enlarge)

Specifically, June monthly income growth was 0.4% which beat estimates for 0.3%. Monthly wages and salaries growth was 0.5% which on top of 0.2%. Yearly real disposable income growth was 3.3%. May’s reading was revised down from 0.5% to 0.4%. The savings rate increased in June from 8% to 8.1%. The cycle trough was 4.9%. Monthly consumer spending growth was 0.3% which matched estimates for 0.3%. Yearly real consumption growth was 2.5%. May’s reading was revised higher from 0.4% to 0.5%.

Inflation Stays Low Enough For Rate Cuts

Inflation stayed low in June. Low inflation is letting the Fed to cut rates on Wednesday and possibly again in September. Headline monthly inflation was 0.1% which matched estimates; core monthly inflation was 0.2% which also matched estimates. As you can see from the chart below, core PCE inflation was 1.6% which missed estimates for 1.7%, but increased from 1.5%. Last June, core CPI was 2%. The recent cycle peak was 2.1% in July. After that, we have the chance to see core inflation increase which could cause the Fed concern. The very easy comps start next March. Headline PCE inflation was 1.4% which missed estimates for 1.5% and was the same as May’s reading.  

(Click on image to enlarge)

Conclusion

The Fed was going to cut rates regardless of what the core PCE inflation rate was. However, it’s still good to see it solidly below 2%, not that there was any chance of it being above 2%. Core PCE rarely misses/beats estimates significantly. I’m interested to see what happens when core PCE starts to spike early next year as the comps get easier. I could see near 2% core PCE in Q1.