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PCE core deflator (June): slightly higher, above the Fed's comfort zone

Tue, Aug 5 2008, 07:18 GMT
by BHF-Bank Economics Department

BHF-Bank

• ISM non-manufacturing index (July): unchanged at contraction level

• Fed funds rate: on hold

Personal income rose by 1.9% mom in May, boosted by the tax cheques. But as only part of the extra income was spent, personal spending only increased by 0.8% mom, while the savings rate jumped from a meager 0.4% to 5.0%. The GDP figures for Q2 indicate that personal income decreased in June, because fewer tax cheques were sent out. We expect personal income to have fallen by 0.7% mom in June. The retail sales report had already indicated that personal consumption spending slowed in June, and GDP figures signal that personal spending will only have risen by about 0.4% mom in June. As the PCE deflator could have reached 0.9% mom, real personal spending will have declined by about 0.5% mom, dampening the average for the third quarteras well.

The GDP report for Q2 showed that the PCE core deflator has been revised up since the 2nd quarter of 2007. As the PCE core deflator went up by an annualised 2.1% qoq in Q2, which was higher than expected, it is likely to have risen by 0.3% mom in June, raising the annual rate to 2.3%, after a probable upward revision of 2.2% for May.

Factory orders could have gone up by about 0.7% mom in June. We already know that durable goods orders increased by 0.8% mom due to ongoing strength in defense orders. Growth in non-durable goods orders, which now make up a greater share of total factory orders, is likely to have been supported again by rising energy prices, albeit to a lesser extent than in the previous three months.

The ISM non-manufacturing index fell back sharply from 51.7 to 48.2 in June – unlike its manufacturing counterpart, which had temporarily exceeded the expansion threshold by rising to 50.2. The surge in energy costs was an important reason for the decline in the assessment of the services sector, and the new orders and employment components suffered the most. The manufacturing index only fell to 50.0, but we are not expecting the ISM nonmanufacturing index to have rebounded in July, as small business optimism has reached a cyclical low. We forecast that the ISM non-manufacturing index will have remained unchanged in July.

After having lowered the fed funds rate at each of the previous seven meetings by a total of 325 basis points, the FOMC left its key rate stable in June. At that time the committee considered the downside risks to growth to have diminished somewhat, whereas the inflationary risks were seen to have increased. Therefore at that meeting, one member even voted for a slight increase in the target. Although the FOMC minutes showed some discussion about the need to change monetary course, Fed chairman Bernanke indicated that the fed funds rate would remain at 2.00% in August: when he presented the monetary policy report before Congress in mid-July, his risk assessment was fairly balanced, and in view of the worries about the financial condition of Fannie Mae and Freddy Mac, he pointed out that helping the financial markets to return to more normal functioning would continue to be a top priority for the Fed. The August FOMC statement might indicate downside risks to growth due to higher energy prices, tighter credit conditions and a still-deeper contraction in the housing market. At the same time, the committee will continue to emphasize the upside risks to inflation, even though oil prices have fallen back somewhat and core inflation rates and wage increases still seem quite moderate.
But the committee might want to convince financial markets that the Fed remains alert to any indications that the inflationary impulses from commodity prices are becoming embedded in the wage- and pricesetting process.

Initial jobless claims rose from 404k to 448k in the week ending 26 July, the highest level since April 2003. The jump in jobless claims reflects labour market weakness, but it could also be related to the usual summer shutdowns in the automobile sector. Moreover, the extension of benefits, which was signed into law recently, has probably not only pushed up continuing claims, but initial claims as well due to miscountings. At 420k, we expect initial jobless claims to have remained elevated in the week ending 2 August.

Pending home sales fell back sharply by 4.7% mom in May, but as they had risen by 7.1% in April, they only lost part of their previous gains. Given the still fragile state of the housing market, we expect pending home sales to have fallen again by at least 1.5% mom in June.

The GDP report showed that non-farm production went up by an annualised 1.7% in the 2nd quarter. As aggregate working hours fell, non-farm productivity could have increased by an annualised 2.4% qoq in Q2. Unit labour costs might have gone up by an annualised 1.4% qoq.

Wholesale inventories went up sharply by more than 2% in April and May. The nominal increase in shipments was even more significant, particularly due to the sharp rise in petroleum prices, and thus the inventories- to-sales ratio dropped further to a new low of 1.08. We expect the increase in wholesale inventories to have slowed to 0.4% mom in June.

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Published on  Tue, Aug 5 2008, 11:46 GMT