Fed rate cut likely as inflation slows and retail sales boost economic outlook

U.S. budget deficit climbs 10% in July

The U.S. budget deficit, when the federal government’s spending exceeds its revenues, increased by 10% from a year ago due to higher government spending and larger interest payments on the national debt. The gap between federal spending and collected taxes also increased, from $221B last year to $224B last month. For the full fiscal year, the total deficit hit $1.52T with two months remaining, slightly down from the deficit of $1.61T in the same period last year. However, the 2024 deficit is on track to end up around $1.90T compared to last year’s $1.70T. One of the largest contributors to this deficit is the increased interest payments the government has been making on its record $35T national debt. Through the first ten months of the fiscal year, the U.S. government has spent $763B on interest payments, more than its spending on Medicare or the military.

PPI and core PPI point to slower inflation

The Producer Price Index (PPI), a measure of average price changes seen by manufacturers and producers, was 2.20% for the last 12 months ending in July, a marked slowdown from the 2.70% increase from June’s measures. Markets responded positively to this slowdown, with the Dow, S&P 500, and Nasdaq registering gains after Tuesday’s news. Often touted as an indicator of retail-level inflation in the coming months, the July data showed a critical insight into price changes affecting everyday consumers. When excluding more volatile energy and food prices, core PPI prices were flat, bringing the annual gain down to 2.40%, the lowest value since March. While closely watched as an indicator of how inflation is trending in the months to come, attention shifted to Wednesday’s release of the CPI and core CPI numbers.

CPI at three-year lows

Price hikes slowed more than expected during July, with the Consumer Price Index (CPI) falling below 3.00% for the first time in more than three years. With June’s annual gain coming in at 3.00%, the July slowdown is indicative to many that a Fed rate cut at the upcoming September meeting is all but certain. Month-over-month, prices rose 0.20% after a 0.10% decline in June, while the cost of owning or renting a home increased by 0.40%. This increase in the “Shelter Index” accounted for nearly 90% of July’s overall price increase, as reported by the Bureau of Labor Statistics. On an annual basis, the Shelter Index is up 5.10% through July, though it has steadily declined since peaking at 8.20% in March 2023. Sohn further noted that “if you look at the future, it’s pretty clear that the inflation picture will continue to improve.”

Jobless claims and retail sales

July monthly retail sales increased by 1%, continuing to ease concerns about a potential imminent recession. Additional data highlighting the decline in weekly jobless claims reinforces the strength of the U.S. labor market. The long-term trend of retail sales data remains positive, with July’s year-over-year retail sales up by 2.70%. Jobless claims fell this past week, coming in at 227,000, down from the revised 234,000 in the prior week. The decline is a welcome sign that the U.S. labor market is on solid footing. Given the strong growth and jobs data, the likelihood of a soft economic landing has increased. Chair Powell has echoed the sentiment that the Fed will base its decision on the “totality of the data,” and many feel that recent data confirms that a rate cut in September is likely. CME FedWatch indicates that 74.50% of the market is pricing in a rate cut to a target rate of 500–525 basis points, with 25.50% expecting a target rate of 475–500 basis points.

The week ahead

Powell will speak on Friday at the Jackson Hole retreat to deliver remarks on the economic outlook, offering a chance to provide an updated assessment of the U.S. economy and its trajectory in the coming months. Additionally, service and manufacturing PMI numbers will be coming in on Thursday.