Inflation Misses Estimates, Giving The Fed A Chance To Pause Rate Hikes


Inflation - Contributions To Core PCE Inflation

The chart below shows what each portion of core PCE needs for it to be up 2% year over year. As you can see, housing services has seen a minor decline in its contribution, but it’s still running above the rate needed for 2% core PCE.

Core goods excluding pharmaceuticals hurt core PCE growth, but is above its target for 2% core PCE. On the other side, both healthcare services plus pharmaceuticals and core services excluding healthcare and housing are running below their target for 2% core PCE.

This explains why it was only 1.8% in October. Soon housing services will join them below its target which will push core PCE growth closer to 1% than 2%.


Inflation - Strong Income & Spending Growth

This was a great report for the consumer because inflation missed estimates while income and spending growth beat them. Real wage growth will be very strong in the last couple months of the year. This was due to weak inflation and accelerating nominal wage growth.

Wage growth hasn’t driven inflation which has allowed for the possibility of strong real wage growth.

On a month over month basis, personal income growth was up 0.5% which beat estimates for 0.4% growth and the prior reading of 0.2% growth.

Consumer spending growth was 0.6% month over month which beat estimates for 0.4% growth. This beat makes sense as the September report was revised to show 0.2% growth instead of 0.4% growth.

As the chart below shows, both real consumer spending and real disposable income growth have recovered from their 2016 lows, but neither have reached their peak in early 2015.

Spending growth is faster than income growth which implies the savings rate is falling. It’s not as bad as 2016 when spending growth was almost 2% higher than income growth.


Inflation - Conclusion

The Fed can lower its guidance for 2019 rate hikes in December and eventually pause rate hikes to extend this expansion as core inflation is starting to fall. If the Fed doesn’t change its guidance, the yield curve will invert which implies a recession in 2020 is probable.

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