Inflation Slows, But US Consumer Spending Remains Under Pressure

US inflation is slowly cooling down, according to recent data. The July core PCE deflator, the Federal Reserve's preferred measure of inflation, came in at 0.2% MoM/3.3% YoY, as expected. This month-on-month rate is crucial for the Fed, as it will eventually lead to an annual rate of inflation converging on 2% over time.

However, markets are still pricing a 25bp rate hike before year-end, while economists favor an extended pause for policy rates. The chart shows that core PCE deflator is tracking slightly higher than the core CPI, but revisions to the calculation methodology next month may bring them closer together.

Meanwhile, consumer spending remains under pressure as real personal spending for July was 0.0% MoM, and second-quarter GDP was unrevised at 1.5% quarter-on-quarter annualized growth. Real household disposable income rose 0.4% MoM, but has effectively flatlined for over a year and is below the pre-Covid trend.

This explains the K-shaped consumer narrative, where middle and lower-income households are under financial pressure due to low savings ratios and high credit card and auto loan delinquencies. In contrast, higher income households have more spare capacity, driven by surging household wealth and the top 20% of households holding 70% of household wealth.