– Cooling core PCE at 0.08% in May offers promising signs for disinflation to hold.

– Real consumer spending seems to be moderating in the first half.

– Housing market’s recent comeback is fizzling.

– We expect June to see payroll gains of 200k and a steady unemployment.

While the upcoming election dominates headlines, economic data reveals a more nuanced picture. Growth remains modest, but disinflationary trends are back on track. Core PCE, the Fed’s preferred gauge, rose a mere 0.08% in May, pushing the annual rate down to 2.6%. This suggests a return to the disinflation seen earlier this year. This, combined with moderate consumer spending growth (0.3% in May), might allow the Fed to cut rates starting in Q4.

Business investment offers a glimmer of hope. Q2 is expected to see a bump thanks to aircraft orders, vehicle sales, and imported capital goods. However, domestic manufacturing orders and shipments remain stagnant. Housing’s earlier recovery sputtered, with new and pending home sales dropping in May. Rising unsold home inventories could further dampen construction in the latter half of the year.

The labor market presents a mixed bag. Initial jobless claims eased slightly, but continuing claims hit a high not seen since late 2021. We expect next week’s shortened workweek to deliver nonfarm payroll gains of 200k and an unchanged unemployment rate of 4.0%.t rate of 4%. May’s core PCE price increase of just 0.083% (three decimals) marks the softest monthly reading since late 2020 (Figure 1). Similarly, growth in services excluding housing came in tepid at 0.1% month-over-month (3.4% year-over-year), and overall inflation remained flat (2.6% year-over-year). This is welcome news for the Fed, though policymakers will likely wait for more consistent low readings to feel confident inflation is truly returning to the 2% target.

Over the past quarter, core inflation rose at a 2.7% annualized rate, down from a peak of 4.5% in March. While this reinforces the narrative of Q1’s inflation spike being a temporary blip, the May data might overestimate how quickly core prices will actually cool. Nevertheless, we expect the Fed will find this trend encouraging enough to initiate rate cuts starting in Q4. May’s consumer spending growth of 0.3% (0.26% after adjustments) translates to a 1.4% annualized rate for Q2. This raises concerns that overall Q2 growth might fall slightly below 2%. Originally reported at 2.5%, then revised to 2.0%, Q1 growth now sits at a lower 1.5% after Thursday’s final GDP revision. This represents a significant slowdown compared to the over 3% growth seen in the second half of 2023. However, a relatively strong job market and wage gains should help support consumers.

May’s personal income and spending data hint at this, with nominal income rising 0.5% and compensation up 0.6%, both month over month. Flat overall prices during the month led to a robust 0.5% increase in real disposable income, the highest in a year. However, the quarter paints a different picture, with real disposable income growing at a more moderate 1.4% annualized rate, similar to Q1’s 1.3%.

Post debate thoughts for the upcoming election — though the Biden administration has not been a staunch champion of free trade, maintaining the Trump tariffs on Chinese imports and selectively raising them further, a second Trump administration would be considerably more protectionist than another Biden term. Trump has floated two potential policies: a 60% tariff on all Chinese imports and a 10% universal tariff. The Trump 1.0 tariffs raised the trade-weighted average tariff from roughly 1.5% to over 3%, generating an extra $60 billion in customs revenue. If this burden fell solely on consumers, it would have increased consumer prices by around 0.3%. However, evidence suggests less than full pass-through to consumer prices, with retailers and businesses absorbing some of the higher tariffs, while domestic producers may have exploited increased market power to raise prices. Thus, 0.3% is a plausible estimate of the price level effect of those tariffs.

Applying similar logic, a 60% tariff on all Chinese imports – a 48%-point increase – would statically generate just over $200 billion, raising the price level 1.1%. A 10% universal tariff yields $280 billion, or about 1.5% on the price level. Moving from a static to a dynamic calculation could significantly alter results for the Chinese tariff, as substituting away from China might be easier than substituting away from imports altogether. Unlike other topics discussed, the future of fiscal policy hinges on both the presidential and Congressional elections. The victors will immediately confront the expiration of key personal tax provisions of the 2017 Tax Cut and Jobs Act at the end of 2025. These include lower tax rates, expanded child tax credit, increased standard deduction, increased estate tax exemption, and a passthrough income deduction. If these expire as currently written, tax revenue is projected to rise by almost $400 billion annually, or roughly 1.3% of GDP.

President Biden intends to effectively extend TCJA provisions for those earning under $400,000, but revert to older, higher rates above that threshold. Biden’s plan also raises the net investment income tax and additional Medicare tax bases for those earning over $400,000. For businesses, Biden proposes increasing the corporate rate from 21% to 28%, raising the GILTI tax rate to 21%, and implementing miscellaneous revenue increases. After factoring in revenue lost from an expanded child tax credit and other tax credits, Nick’s plan would raise approximately $150 billion annually, or about half a percent of GDP. The Trump campaign has been less clear on their fiscal plans. Trump favors a broad tax cut across classes and businesses. Presumably, he and Congressional Republicans would extend all TCJA provisions.

If Trump needs to compromise with a Democratic-controlled House, the corporate tax rate might rise. Additionally, any revenue from higher tariffs would likely fund TCJA extension or expansion under a Trump White House.

Initial jobless claims have dropped in the past two weeks following a steady climb since late April, and we anticipate another slight decrease to 230k in the week ending June 29 from 233k the previous week. Some recent increases might be due to seasonal adjustment issues, like last year’s temporary rise around the same time, and potential volatility around the late-May Memorial Day holiday. Nonetheless, it’s crucial for the labor market to observe whether claims will recede in the following weeks or rise again. Continuing claims reached a new post-COVID peak in the week ending June 15, though not significantly above late last year’s levels. They may rise further due to the recent uptick in initial claims.

The nominal trade deficit is projected to increase to -$77.4 billion in May from -$74.6 billion in April. This is mainly due to a decline in goods exports (2.7% m/m) exceeding the fall in goods imports (0.7% m/m), widening the goods deficit. Meanwhile, trade in services has been relatively stable recently, deviating from the general upward trend, which is expected to resume soon. The services balance should remain fairly steady, having rebounded sharply through early 2023 after shrinking during and after COVID, and has since stabilized near pre-pandemic levels.

The services PMI business activity index rose to 55.1 in the June flash report from 54.8 in May, slightly above May 2023 and the highest since spring 2022. We anticipate it to remain mostly unchanged in the final report. However, other measures in the report are less robust than business activity, with new business and employment indexes not as high compared to their recent history and at the lower end of the pre-COVID range, suggesting a potential future decline in overall business activity. Both input and output price measures in the services PMI have been generally trending lower, with output prices returning to normal pre-pandemic levels. While a further slight decrease in input prices would be welcome, neither price measure is currently a major inflation concern.

The ISM services composite index is expected to slightly decline in June, following a significant jump to 53.8 in May from 49.4 in April. The business activity and supplier deliveries indexes, which rose sharply last month, may partially retrace their gains. However, there’s room for improvement in the new orders and employment indexes, currently on the lower end of their historical range during expansions. This contributes to the overall ISM composite remaining relatively low compared to pre-pandemic levels, despite solid GDP growth and payroll gains. Other services surveys released during the month generally showed improvement from May. General business activity in the services PMI slightly increased in June, with the gap between May’s ISM business activity index and June’s PMI metric not unusually large. Regional Fed surveys show mixed results: general activity indexes rose in Dallas and Philadelphia, but weakened in Richmond. The employment index has been notably weak recently, signaling a potential recession at its current level of 47.1, despite a slight increase in May. This decline began late last year, contrasting with the more optimistic payroll data. It’s worth monitoring whether this index declines further.

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