The Federal Reserve's preferred inflation gauge, the personal consumption expenditures (PCE) price index, unexpectedly held steady in July. Concurrently, the second estimate of US second-quarter GDP kept the annualized growth rate at 1.5% unchanged, although both consumer spending and business investment saw upward revisions from initial figures. However, real consumer spending in July was flat month-over-month, indicating some cooling in the economy after robust growth in early summer. Analysts believe these data points further reinforce the case for the Fed to remain on hold for now. While inflation has notably receded from its peak, it remains sticky, and risks from trade policy uncertainty and rebounding energy prices persist, prompting caution in the Fed's future policy path. Investors are closely watching Fed Chair Warsh's speech at the Jackson Hole global central bank symposium on Friday for clues on how policymakers assess stubborn inflation and the direction of policy. Economists Troy Durie, Andrew Sacher, and Anna Wong noted, "The main takeaways from the July personal income and spending report are that underlying inflation trends are relatively moderate and real spending is lackluster. We expect the Fed to remain on hold for the remainder of the year."

Inflation Remains Sticky with Moderate Monthly Pickup

Data from the Commerce Department's Bureau of Economic Analysis on Wednesday showed the PCE price index rose 3.7% year-over-year in July, matching June's pace and still well above the Fed's 2% target, slightly exceeding economists' expectations of 3.6%. On a monthly basis, PCE increased 0.2%, in line with market forecasts, following a 0.1% decline in June, which was the weakest reading since April 2020. Excluding food and energy, the core PCE index rose 0.2% month-over-month and 3.3% year-over-year in July. This metric has now exceeded the Fed's 2% target for 65 consecutive months since February 2021. PCE peaked at 7.2% in June 2022, after which the Fed initiated its most aggressive rate-hiking campaign since the 1980s, gradually bringing inflation down. However, new rounds of import tariffs introduced after Trump returned to the White House last year pushed up prices across a broad range of goods, and subsequent US and Israeli airstrikes on Iran triggered an energy price surge, complicating the inflation picture once again. In May of this year, the year-over-year PCE increase briefly rose to a three-year high of 4.1%, as the US-Iran conflict disrupted roughly one-fifth of global oil supply, driving energy prices sharply higher. Six months later, while the conflict remains unresolved, exchanges of fire have diminished, and oil prices, along with the broader inflationary pressures they triggered, have retreated from spring peaks. Structurally, the moderate monthly inflation increase in July masked underlying details: real spending on core goods fell 0.8%, while services spending rose 0.3%. The services inflation metric excluding energy and housing rose 0.3% month-over-month, a gauge some Fed officials view as a key reference for domestic inflation pressures. Notably, the Bureau of Economic Analysis will adjust its price measurement methodology for certain categories starting next month, covering areas such as legal services, computer software, and investment advisory. Many economists anticipate the adjusted core PCE readings may be revised lower, potentially influencing judgments about the future inflation trajectory.

Q2 GDP Maintains 1.5% with Stronger Consumption and Investment

The second estimate of second-quarter GDP released the same day showed inflation-adjusted GDP grew at an annualized rate of 1.5%, consistent with the initial reading and down from the 2.1% pace in the first quarter. However, the underlying details were more optimistic. Consumer spending, which accounts for more than two-thirds of US economic activity, grew at an annualized rate of 3.4%, up from the initial estimate of 3.2%. Nonresidential fixed investment rose 8.5%, indicating resilient business investment intentions. A narrower measure of underlying demand, final sales to domestic private purchasers, was revised up to 4.2% growth from the initial 3.9%, marking the strongest pace in over three years. This metric excludes net exports, inventories, and government spending, and tends to better reflect the economy's endogenous demand momentum. Government spending fell at an annualized rate of 1% in the second quarter, primarily reflecting a significant decline in non-defense-related expenditures. Meanwhile, the core PCE price index for the second quarter was revised up to a 3.6% annualized increase from the initial 3.4%, indicating inflation pressures in the quarter were slightly higher than first estimated.

July Real Spending Stalls, Savings Rate Hits Four-Month High

Despite strong second-quarter consumer spending, momentum has clearly weakened entering the third quarter. July data released Wednesday showed inflation-adjusted real consumer spending was flat month-over-month, following robust gains in both May and June. Nominal personal income rose 0.4% month-over-month, with wages and salaries up 0.3%. After adjusting for inflation, real disposable income increased 0.4%. The savings rate rose to 3%, the highest level in four months. Although the July spending stall was partly attributed to temporary factors—Amazon's (AMZN.US) Prime Day promotion moved from July last year to June this year, potentially pulling forward some consumption and dampening July figures—economists remain cautious about the outlook. Average US gasoline prices have climbed back above $4 per gallon, potentially restraining consumer spending on other goods and services. Additionally, the extra buffer from higher-than-normal tax refunds earlier may have faded. Retailers including Walmart (WMT.US) have indicated that price-sensitive consumers are still spending but are increasingly seeking deals and featured items, reflecting more cautious purchasing behavior.

Fed Policy Divergence and Rising Trade Uncertainty

The inflation data arrives amid intensifying debate within the Fed over the rate outlook. At the July Federal Open Market Committee meeting, a majority of members voted to hold rates steady in the 3.50% to 3.75% range, marking the fifth consecutive pause since December. The recent two-month decline in inflation supports maintaining rates, but the slow pace of improvement may not convince the minority of officials advocating for further tightening. These officials argue that with inflation having exceeded target since February 2021, it will be difficult to return to 2% without additional demand restraint. Meanwhile, new trade uncertainties are building. Trade negotiations with Canada, the US's second-largest trading partner, broke down last Friday, triggering new tariffs on $20 billion of Canadian goods. Both Washington and Ottawa have since announced additional retaliatory measures that will take effect over the coming months unless an agreement is reached. This could introduce new tariff-related price pressures, further complicating the Fed's policy choices. Following the data release, US Treasury yields and the dollar moved higher, while US stock index futures retreated. Futures markets still show roughly a 40% probability of a rate hike in September. Market attention is now turning to Fed Chair Warsh's speech on Friday at the Jackson Hole symposium in Wyoming. Investors are seeking further signals on how the Fed is addressing stubborn inflation, particularly whether the central bank will maintain patience amid the coexistence of slowing growth and persistent price pressures, and what the potential path for future policy adjustments might be. Since taking office in May, Warsh has maintained a cautious approach to policy direction, preferring to let markets play a guiding role. However, US government bond yields have continued to climb recently. Both 10-year and 30-year Treasury yields have risen to their highest levels since 2007, just before the global financial crisis. This yield surge is driven by multiple factors, including investor skepticism about the Fed's commitment to its inflation target and concerns over debt and deficit issues in the federal budget. Although Treasury Secretary Scott Bessent announced a plan a week ago for the Treasury to increase bond buybacks, market participants remain skeptical about whether this measure can have a meaningful impact on yields.