US PCE inflation for July bounces to 3.3%, on fuel surge

2 Sep 2023 , 01:08 PM

Every month, the US announces two different types of inflation number from a consumer perspective. Interestingly, both are consumer level inflation only and they both also tend to correspond over time. The first type of consumer inflation is the CPI inflation, which is announced by the US Bureau of Economic Analysis (BEA) around the middle of each month for the previous month. The second type of consumer level inflation is based on personal consumption expenditures (PCE) and is also referred to as PCE inflation, which looks at inflation from a consumer spending perspective rather than from a price basket perspective. The PCE inflation is generally announced towards the end of the month for the previous month. For the month of July 2023, the PCE inflation was announced on August 31, 2023. The PCE inflation, which had fallen to 3% for June 2023, has bounced back to 3.3% in July 2023. PCE inflation is the reference point for the Fed to decide on the rates trajectory.

PCE inflation for July 2023 bounces to 3.3%

The PCE inflation for the month of June 2023 came in sharply lower at 3% and is now on par with the CPI inflation. The table below captures the PCE yoy inflation over the last 5 months.

Month	Headline PCE Inflation	Core PCE Inflation
February 2023	5.0%	4.7%
March 2023	4.2%	4.6%
April 2023	4.3%	4.6%
May 2023	3.8%	4.5%
June 2023	3.0%	4.1%
July 2023	3.3%	4.2%

Data Source: Bureau of Economic Analysis (US)

While all the other PCE inflation numbers have remained static, the May inflation has seen the core PCE inflation and the headline PCE inflation being upped, showing that the price pressures may have been underestimated and the Fed may actually be correct on being paranoid about inflation. Like in the case of US consumer inflation, the PCE inflation is also split into food PCE inflation, fuel PCE inflation, core PCE inflation and headline PCE inflation. The core PCE inflation is the residual PCE inflation that is left after the cyclical food and fuel inflation are removed. The core inflation tends to be more secular in nature and hence in terms of policy it is the stickier problem to contend with. The headline inflation is a combination of food inflation, fuel inflation and the structural core inflation.

If you look at the trend, the headline PCE inflation has fallen from a high of 5% to 3.3% between February 2023 and July 2023. So, even after the minor bounce in July, the PCE number is still lower YTD. But what is more gratifying is that the core PCE inflation which had been static at around 4.6% for the last 3 months has fallen to 4.2%. Also, in July 2023, when the headline inflation has risen by 30 bps, the core inflation is up by just 10 bps.

PCE inflation is different from the consumer inflation in the sense that the former focuses more on consumption expenditure on various items rather than just the prices. Hence it is an index of price pressure as well as the trends in consumer spending. That is why the Fed uses the PCE inflation as the benchmark for ideating on the rate trajectory.

What we read from PCE inflation report for July 2023

There is a small difference on where these two inflation reports originate from. The consumer inflation in the US is published by the US Bureau of Labour Statistics (BLS), while the PCE inflation is published by the US Bureau of Economic Analysis (BEA). Here are some of the key inferences we took away from the PCE inflation report for July 2023.

1. For the month of July 2023, the headline inflation bounced by 30 bps to 3.3% while the core PCE inflation bounced by just 10 bps to 4.2%. This bounce in PCE inflation comes after nearly 3 months of downward trend and almost mirrors how the consumer inflation has behaved in July. The eventual target for the Fed is to take the headline PCE inflation toward 2% and the core PCE inflation also towards the target of 2%, after stabilizing it at around 3% first. The PCE inflation for July 2023, certainly justifies the hawkish tones of the Fed members, but we will come back to that later.

    

2. The PCE inflation may have bounced in July, but the broad trend over the last 6 months is still of cooling PCE inflation. While peripheral pressures are still there, the PCE inflation overall is receding, and that is the good news. One related concern would be the second GDP estimate for Q2, which has been lowered from 2.4% to 2.1% an that does raise a concern that the fears of a hard landing may not be entirely unfounded.

    

3. If you break up the items in PCE inflation, there are a lot of sub-trends we cannot miss out. While the PCE inflation for durable and non-durable goods has been in the negative, the services inflation is inordinately higher. For example, durable goods prices contracted by -0.8% and non-durable goods by -0.2%, but the services inflation saw a surge of 5.2% in July, and it is back to the May 2023 levels, after briefly falling in June.

    

4. What is interesting is to compare the food, energy and core inflation between June and July 2023. PCE food inflation tapered further from 4.6% to 3.5% between June and July 2023. However, the contraction in fuel inflation narrowed from -18.9% to -14.6%, in the light of the sharp rise in global crude prices. With core inflation rising by just 10 bps between June and July, most of the spike in PCE inflation in July came from higher energy goods and energy services.

    

5. Personal income increased by $45 billion (0.2% monthly) in July 2023. For the month of July 2023, the disposable personal income (DPI), which is the personal income less personal current taxes, increased by $7.3 billion (sub 0.1% monthly) while the personal consumption expenditures (PCE) increased by $144.6 billion (0.8%) for July 2023. The pressure has clearly come from inflation spiking consumption spending, which resulted in a sharp fall in disposable incomes during the month.
6. Let us look at the break-up of the $144.6 billion spike in current-dollar PCE in July 2023. This constitutes $102.7 billion rise in spending for services and $41.9 billion higher spending for goods. Within the gamut of services, the major contributors to the spike were financial services, insurance, portfolio management and housing and utilities. Services have taken away a chunk of the family budgets and that is also evident in the 5.2% spike in services PCE inflation in July 2023.

    

7. The latest PCE number raises some fresh risks. Services PCE has doubled in July over June and that is not good news. Services inflation is more discretionary in nature and hence harder for the government to control through policy measures. The only way is to tighten rates further, but that would have its own repercussions. For now, the Fed reasoning for higher rates looks justified. That is something even Jerome Powell spelt out quite vividly in his speech at Jackson Hole. He not only underlined the possibility of higher rates, but also of terminal rates being higher than originally anticipated. 

    

8. That brings us back to the billion dollar question. With PCE inflation still sticky after the spate of rate hikes, can the US economy really manage a soft landing. If one goes by the latest GDP downgrade by 30 bps for the second quarter, it looks less likely that the US can manage a soft landing. The more likely scenario is that the landing may be slightly hard, but the policy ecosystem will help to mitigate the side effects. The US Fed has already sucked out liquidity of $1 trillion from the bond book, so push comes to shove, it has something to fall back upon. 

To sum up the trends, services PCE inflation is raging much faster and consumer spending on services is impacting the disposable income substantially. The pressure is starting to show.

Takeaways from July PCE for the Fed and for India?

For the Fed, it is ratification of its broadly hawkish stance. In the July Fed policy statement, and even at the Jackson Hole symposium, the broad tone was that the Fed was not done with rate hikes. Of course, the Fed did put it more euphemistically, saying that future rate action would be driven by data flows. But it is anybody’s guess what that effectively means? The data from multiple fronts like PCE inflation, consumer inflation and even the second estimate of real GDP growth for Q2-2023 is indicating that inflation is not coming under control at the pace that the Fed would prefer to see. Unless there is a sharp fall in fuel prices, the probability of another sharp fall in inflation is rapidly receding. It also raises question over the much-touted soft landing that the Fed may eventually manage.

What does this PCE number mean for India. For India, there are 3 major imperatives. Firstly, there is the positive side to the story. The RBI had silently shifted out of inflation focus into growth focus with the sole assumption that the lag effect of rate hikes should work. If one goes by the latest GDP data at 7.8% in the Indian context for Q1, the growth engine is still revving along. Secondly, there is a concern that the US may be getting closer to the inflation target while the Indian economy just went mildly farther in June and substantially farther from the target in July 2023. Inflation control will be top on the RBI agenda, especially with the US also showing inflation pressures in the latest reading.

Finally, what the RBI may have managed growth even amidst inflation control, but it has maintained status quo on rates for way too long. The last time that India hiked rates was in February and the last 3 meetings of the RBI MPC have just held status quo on rates. However, with the inflation now at 7.44%, the pressure is on the RBI to hike rates sooner rather than later. For the RBI, in such an eventuality, the concern is not of soft landing versus hard lending. The concerns are whether the robust growth story can be sustained.