With all the activity witnessed this year regarding tariffs and trade tensions, there has been a broad consensus that price levels (#inflation) in the U.S. would likely trend higher, as companies passed through elevated costs to consumers, in an effort to protect profit margins. And while this still may occur to a degree in the back half of the year, through the June #CPI report released yesterday, there have been limited tariff effects displayed in the data.

Last week’s jobs report continued a non-stop barrage of information-flow. Indeed, it seems as if there have been very few times in markets where one has had to interpret so much disparate, and at times conflicting, data relative to the economy and influences on it. In a way, it does harken back to the days of pumping quarters into the Asteroids video game while trying to assimilate all the material coming at you at once.

Over the past few days, we’ve received information that is likely to hold an impact on the market’s perception of the trajectory of interest rates, and will have broader market influences as well. The Consumer Price Index (or #CPI) is the most followed of #inflation measures (it gained a greater than expected 0.47% on a headline month-over-month basis and 3.0% year-over-year), and particularly Core CPI (which excludes volatile food and energy components), which increased strongly at 0.45% month-over-month and 3.29% year-over-year. Yesterday’s CPI report, as always, was interesting in that there was a mix of strength in some areas and trend-developments in others. Both Core CPI and Core Services (ex-shelter) displayed significant gains, while the shelter category picked up by a smaller amount. Even within shelter, the much-followed Owners’ Equivalent Rent measure (or OER) was well behaved at 0.31% month-over-month, but lodging saw a big gain after having declined in the previous month.

The world continues to watch for a pathway to lower interest rates, but despite a modestly softer headline in nonfarm payrolls last week, of 143,000 jobs gained, underlying employment conditions continued to display a resilience that makes any @federalreserve rate cutting in the near- to intermediate-term appear unlikely. Indeed, at 0.48% month-over-month and more than 4% year-over-year the wage growth looked solid, unemployment declined slightly to 4.0%, and prior month payroll revisions were 100,000 jobs greater than previously reported. So, all in all, the labor markets still appear to be in a good place.

As we have argued in recent months, a great deal of progress has been made in combatting high levels of post-pandemic inflation. Still, the likelihood is that most of the meaningful progress is behind us at this stage, and inflation may remain sticky at levels higher than the @federalreserve would ideally like. Indeed, yesterday’s headline CPI increased 0.39% month-over-month, greater than its gains from last month, largely due to energy price gains. That resulted in headline CPI rising to 2.89%, from 2.75% the month prior, on a year-over-year basis, amid unfavorable base effects.

What a way to kick off 2025!
Last Friday’s #JobsReport gave us more revealing data on the status of the jobs market in the U.S. at this stage, and it certainly continued to describe an economy in very healthy shape. The evolution of hiring conditions is something that we are very focused upon, and we will continue to be so over the coming weeks and months. With a new Administration coming in, policies such as immigration reform, government hiring (or closures and layoffs), and incentives to spend more aggressively in places like in energy, will influence the ‘to and fro’ of job-demand in the country.

Yesterday’s @federalreserve move signals something of an ending to a story that has played out for several months now, in terms of the Fed’s rate cutting cycle, associated with what were significantly restrictive interest rates. The #FOMC cut policy interest rates by a quarter-point, to the 4.25% to 4.50% range, and communicated more #hawkishly through the updated dot plot/Summary of Economic Projections (SEP), as well as during the Chair’s press conference. To us, this suggests that we’ve entered a new phase of the rate cutting cycle.

As usual, today’s #CPI report created great anticipation and then introspection upon its release. It’s always amazing that a few basis points (bps), one way or the other, can have such a large impact on market perception, and presumably on the interpretation of how the @federalreserve will react to such a number. The truth, however, is that the #Fed considers a multitude of #inflation readings, with a higher emphasis on the Core PCE measure. Yet, we find ourselves at a point in time where the range of outcomes for inflation related to recently solid economic growth, to newly elected political officials, and to the consequential potential for higher tariffs and higher levels of growth, etc., has led to an enormous focus on this number.

Upon reflection, last week’s #JobsReport was, as always, interesting and helpful for understanding where employment currently stands, which is at the top of the priority list for the @federalreserve. However, the data is also challenging to interpret, in terms of true job growth, given distortions from recent hurricanes in the southeast of the U.S., labor strikes in the Pacific Northwest, and the uncertain impact of these events.

Call it the Couldn’t Possibly Ignore report. That’s how important CPI has been in the past few years, as it has kept markets on edge as to what it means for Federal Reserve policy and interest rates across the curve. It’s still important, but the Fed’s clear focus has shifted toward more balanced priorities, with considerably more emphasis on the labor market for judging how quickly (if at all) to move the Fed funds rate.

CIO Charts of the Week: The Economy Is Doing Better Than We Originally Anticipated

While many called for recession in 2024 due to recent weakness in the labor market, the triggering of the Sahm rule, and generally weaker growth prospects, last week’s GDP revisions from the @bea_news helped to quell many of those concerns for the time being. Real GDP was revised up from 22.9tn to 23.2 tn, thus highlighting that the economy is doing better than previously expected, boasting a 3.0% growth rate quarter over quarter for Q2 and a 3.2% growth rate for 2023. Almost more impressively, GDI, a measure often cited as the better representation of growth through the tracking of income rather than expenditures, had previously been running over $500bn below GDP! This growing discrepancy blurred the picture of the state of the economy and called into question the relative strength of households as they seemed to be spending more via GDP, but not making more via GDI. However, in last week’s revisions, GDI was revised up to match GDP!

The markets have been riveted with a singular focus on one number, as a reflection of the Federal Reserve policy stance, and the primary question has been whether the Fed would cut 25, or 50, basis points (bps) at today’s meeting. As if one number carried as much relevance to financial assets as Pi does to mathematics and physics, in determining a circle’s diameter to its circumference.

A Thread on Today’s Payrolls Report:

There are some jobs reports over the years that are acutely followed by markets and others that are more of an afterthought. Today’s was the former, and the market reaction casts no doubt on the employment data’s importance. We can see the market's focus shifting from inflation to labor market data in the term-premia being priced around important data releases. It is clear that the labor market data has now overtaken inflation as the most important focus for both markets and the Federal Reserve. While the recent labor market data is clearly softer, it is very far from a disastrous indicator of recession, hard-landing, or some pernicious foreshadowing of future consumer weakness. Rather, we continue to believe the job market is moderating from robust post-COVID demand. In fact, almost none of the recent increase in unemployment has been permanent job losers; rather, it was driven by temporary (weather-related) layoffs in August, which reversed this month, and a steady stream of new entrants.

In his conference speech today @federalreserve Chair Powell delivered a jumping off point for a shift in monetary policy that would start to bring the Fed Funds rate down at the next FOMC meeting in a couple of weeks. Specifically, his description of a more balanced economic condition, which has largely normalized and is consistent with pre-Covid growth and inflation levels, sets the stage for such a change in policy.

CIO Charts of the Week: We believe the recent return of chaotic markets likely has its origins in onerously tight policy, which has created increased vulnerability to crowded positioning and stretched valuations for risk.

With the benefit of hindsight, we would note that the first foreshadowing of fragility may have been SOFR spiking on July 2. Shortly thereafter, the US Tech sector, which had risen to >20% above its 200d moving average, reversed dramatically on the largest ever 1-week small cap > tech outperformance!

Today’s CPI report confirms a trend that has been in place for a number of months: inflation moderating to a more normalized run rate level of price gains, and one that should continue to build confidence for the @federalreserve that this part of its mandate has been durably tamed. Therefore, we think today’s and other recent data open the door for a September beginning of a rate cutting cycle.

A Deep Dive on Recent Data: While headline CPI data printed at -0.06% month-over-month and Core CPI printed at 0.06%, the real story of today’s CPI print lies in the services components. June represented another month of very low Core Services (ex-Shelter) readings, which has completely reversed the acceleration seen in the 1st quarter, and is now under the Fed’s 2% inflation target on a 3-month annualized basis 1/ Earlier this week @federalreserve Chair Powell delivered testimony before Congress that underscored the progress that’s been made in both bringing labor markets into better balance after the severe pandemic-era disruptions, and improvements achieved in taming the high inflation rates of that period as well- a narrative which today’s data continues to support. 2/

In a market that’s become obsessed with election results and the question of who will take on the job of leading some of the largest developed market countries, such as the U.S., France, and the U.K., last Friday we had a day of respite to focus on the broader employment picture for the U.S. What that #JobsReport showed us was that while political officials seem to be extremely focused on their own employment prospects, there is a very gradual, but persistent, moderation within the broader employment picture.

Why is the savings rate so low today? Debunking a common myth on ‘Excess Savings’…

There are several widely circulated ‘Excess Savings’ models that show the U.S. Consumer having spent down the above-normal savings accumulated during the pandemic. These models, which are ultimately only illustrative in nature, implicitly assume the natural Savings Rate is ~8% or higher. We believe those assumptions are far too conservative and fail to acknowledge the elevated levels of household wealth today. In fact, we would say that as compared to arguing all Excess Savings are depleted (orange line below) it is more reasonable to argue there has been no depletion of Excess Savings at all (purple line below). Of course, as with most things, the right answer is probably somewhere between the extremes and we believe it is best to look at a range of outcomes.

1/4 How could it be that Excess Savings have not been depleted at all? While many things can influence the Savings Rate (especially anything that affects consumer psychology in a big way), the primary driver in the U.S. over the past 40 years has been wealth (as measured by Net Worth/Disposable Income). It is intuitive that as households experience higher wealth, they feel less need to save. This relationship was crystal clear from 1985 – 2010. The post-GFC period saw a psychological shift towards higher savings, but the relationship returned once the economy finally recovered in 2018. For anyone wondering why the savings rate is so low today, look no further than the new highs in Net Worth/Disposable Income.

2/4

To elaborate on my interview last week on @BloombergTV, as well as my response to @elonmusk, a thread.

Restrictive policy rates have succeeded in slowing the rate-sensitive segments of the U.S. economy (including goods inflation), but a >5% Fed Funds rate is not doing much to slow the insensitive, services-oriented segments. In fact, given the unique historical context, we believe >5% cash rates are doing unnecessary damage to certain cohorts today and may even be supporting services inflation.

1/13 The @sffed visualized this very well in a recent analysis… the components of inflation that are “most responsive” to rates have completely normalized! It is the “least responsive” components that are responsible for the sticky inflation we are experiencing today... there is not much Fed policy rates can do about that.

2/13

Today’s much anticipated #CPI report provided greater detail on the current #inflation picture, and importantly, on what the @federalreserve is most focused upon these days, and unfortunately, it’s hard to see it as anything other than a #setback. Recently, it has become clear that the #Fed is taking on a patient stance with regard to #inflation coming down, but today's report was further evidence that it may take even longer for inflation to finally reach the Fed’s 2% target level.