US spending stalls as inflation makes slow progress towards target
The desk interprets recent economic data indicating that U.S. consumer spending is stalling, while inflation still progresses slowly towards the Federal Reserve's target. Per the full note, the July core PCE deflator remained consistent at 0.2% MoM and 3.3% YoY, reflecting a stable, albeit sluggish, inflation trajectory. Notably, while the market anticipates a potential rate hike later this year, many economists argue for a prolonged pause in rate adjustments, underscoring the mixed consumer fundamentals and flat-lined real incomes. This divergence could shape FX strategies as traders assess the likelihood of Fed action amidst a complicated economic backdrop.
What the desk is arguing
The current economic indicators suggest that inflation in the U.S. is moving at a pace that may prompt the Federal Reserve to reconsider a rate hike before year-end. Per the full note, the July core PCE deflator's alignment with expectations illustrates a persistent inflation environment that remains under scrutiny.
The inflation rate, standing at 3.3% YoY, might appear stable, but the lack of real income growth signals vulnerabilities in consumer spending, complicating the Fed's policy outlook. While markets are pricing in a 25 basis point rate hike, the economic fundamentals advocate for cautious optimism, as evidenced by the stagnant GDP growth reported in Q2.
Where it sits in our coverage
Based on our internal coverage, a consensus target for USD/EUR remains at 1.075, while specific firm forecasts suggest varied outlooks: - jpmorgan: 1.10 (Mar-26) - bofa: 1.04 (Mar-26)
This perspective indicates that the desk's positioning aligns with jpmorgan at the upper end of the range, diverging from bofa's more conservative view.
How other firms see it
Firms such as jpmorgan and others perceive the market as likely to reflect continued Fed patience, whereas bofa remains skeptical about inflation progress supporting aggressive monetary policy actions. This contrast highlights differing inflation outlooks that may influence cross-border capital flows and currency valuations.
Market participants should keep an eye on correlated currency pairs like EUR/USD, as they are likely to reflect shifts in market expectations regarding the U.S. economic landscape and the Fed’s monetary policy trajectory.
How firms align with this view
Aligned with the desk view
Contrary positioning
Key takeaways
- 01U.S. inflation shows slow progress toward the target, with core PCE at 3.3% YoY.
- 02Consumer spending stalls amid stagnant real incomes, complicating the Fed's rate hike considerations.
- 03Market anticipates a potential 25 basis point rate hike, though economists favor a prolonged pause.
- 04The current economic backdrop encourages cautious optimism, affecting FX strategies.
Market implications
Traders should watch the USD/EUR closely, particularly around the 1.075 mark, as market sentiment evolves regarding the Fed's potential rate decisions. Shifts in inflation data could provide critical signals for positioning in response to this uncertain economic environment.
Risks to this view
If inflation unexpectedly accelerates beyond current forecasts, or if consumer spending rebounds significantly, this could lead to a faster-than-anticipated rate hike by the Fed, ultimately reversing the current market expectations.
Older quick take Quick take Published 14:41 United States US spending stalls as inflation makes slow progress towards target Inflation continues to make slow progress towards target, leaving the possibility of a rate hike this year firmly in play, but consumer fundamentals remain soft due to flat-lining real incomes July's US core PCE deflator came in line with expectations as inflation continues its slow progress toward the target level Share X LinkedIn E-mail Copy link Share X LinkedIn E-mail Copy link Download James Knightley Chief International Economist, US Inflation is cooling, albeit slowly July's US core PCE deflator, the Federal Reserve's preferred measure of inflation, has come in at 0.2%MoM/3.3%YoY, as expected. The headline inflation rate was a touch firmer than anticipated at 0.2%/3.7%, but that is OK. As long as the month-on-month rate continues to come in close to 0.2% MoM, the annual rate of inflation will converge on 2% over time, but the question is how much more patience the Fed actually has.
Markets continue to price a 25bp rate hike before year-end while economists, in general, still favour an extended pause for policy rates. The chart below shows the year-on-year rate of inflation for the core PCE deflator and the core CPI. Core PCE is obviously tracking a little higher, but we are going to have some major changes to the calculation methodology next month surrounding insurance and portfolio management fees, amongst other things.
With revisions coming through too, they should converge a little more. We continue to argue that tariff refunds, weak wage growth, softening housing rents and stability in energy markets will continue nudging inflation closer to 2% on both metrics over the coming 12 months, hence our view on stable Fed funds through well into 2027. Core CPI versus core PCE deflator YoY% Source: Macrobond, ING "> Source: Macrobond, ING Consumer fundamentals remain under pressure as spending stalls Meanwhile, second-quarter GDP was unrevised at 1.5% quarter-on-quarter annualised growth.
Real personal spending for July was 0.0% MoM, confirming the soft start to the quarter from the consumer despite real household disposable income doing OK, rising 0.4% MoM. This result is the savings ratio rising from 2.6% to 3%. In terms of economic activity, the key story is real household disposable income – that is, incomes after tax and adjusted for inflation.
It is the primary driver of spending power and suggests underlying consumer fundamentals remain under pressure. The chart below shows that RHDI has effectively flatlined for well over a year and is well below where the pre-Covid trend suggests we should be. Employment growth has been modest while wage growth has slowed and elevated inflation prints have eroded spending power.
Tax changes (no tax on tips/overtime etc), have not meaningfully improved the situation. This is key to explaining the K-shaped consumer narrative. Middle and lower-income households are reliant on income to fund their spending and are under financial pressure – hence the low savings ratio of 3% versus the 6% long run average and the fact credit card and auto loan delinquencies are at or close to all-time highs.
However, higher income households have more spare capacity with surging household wealth encouraging the top 20% of households by income to continue spending – remember the Federal Reserve states that the top 20% of households by income hold 70% of household wealth. Real Household Disposable Income (2017 $bn) Source: Macrobond, ING "> Source: Macrobond, ING US Spending Inflation Federal Reserve Content Disclaimer This publication has been prepared by ING solely for information purposes irrespective of a particular user's means, financial situation or investment objectives. The information does not constitute investment recommendation, and nor is it investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument.
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