Stocks are lower after the S&P 500 set a new all-time closing high yesterday. Mortgage Bonds are slightly lower to start the day, following slightly hotter core inflation data, but in line with what the market and Powell expected.
Personal Consumption Expenditures (PCE)
The Fed’s favorite measure of inflation, PCE, showed that headline inflation rose 0.2% in July, which was as expected. Year over year, inflation remained at 2.6%, which was also exactly in line with market estimates.
The Core rate, which strips out food and energy costs and is the Fed's main focus, rose 0.3% as well, which was in line with expectations. Year over year the core rate rose from 2.8% to 2.9%...but that too was anticipated by the market.
The three month core run rate increased from 2.52% to 2.94%, which is going in the wrong direction, but is likely elevated due to the temporary impact of the tariffs. The six month run rate decreased slightly from 3.09% to 2.95%. Both of these figures are down from their February run rates of 4.1% and 3.4% respectively.
Something that is skewing inflation higher is the 5.4% rise in Portfolio Management, and based on its weighting, added 0.1% to the inflation readings. We don’t believe that this is actually inflation. In most cases, financial advisors charge a management fee on their assets under management. It can range and is usually somewhere between 1-2%. Since asset prices have continued to rise, including Stocks and Bonds over the last year, investors’ portfolios have grown, causing a higher fee in dollars - but the rate they are being charged has remained the same.
Example: An investor has a portfolio worth $500,000, and they are being charged a 2% fee annually to manage the account, costing them $10,000 per year. If their portfolio rose in value to $600,000, the 2% fee would result in a $12,000 fee…but the fee rate has not changed, their portfolio rose in value and that same fee is being charged to a higher valued asset base. In this example, the investor still is better off by $98,000. This is not inflation and is overstating it by 0.1%.
Shelter was pretty well behaved in this report, rising 0.27% last month and 4% year over year. Rent rose 0.26%, while Owners’ Equivalent Rent rose 0.28%. Based on more real-time indicators showing blended rents at 2.6%, and the weighting of Shelter within Core PCE, year-over-year Core PCE is being overstated by 0.2% and should be closer to 2.7%.
Going forward, the August report that will be released at the end of September will be another one where it will be tough to see progress, as the Core PCE replacement from the previous year is very low at 0.17%.
Personal Incomes rose 0.4%, while Spending rose 0.5%, both right in line with estimates.
Bottom line, the Bond market took the report pretty well even though YoY Core PCE did rise 0.1%. As we mentioned yesterday, we did not think Bonds would react too negatively if the report was in line with estimates, as everyone was expecting Core PCE to rise due to the temporary impact of tariffs that is now being captured. Today’s report should have no impact on the chances of a September 17 rate cut.
Fed Governor Waller Comments
Fed Governor Waller, who is a voting member and one of the leading candidates for the next Fed Chair, eloquently laid out his thoughts on the labor market, inflation and monetary policy in his speech yesterday.
Waller believes that after the revisions come in for June and July, that there will be outright job losses over the May to July time period. He also mentioned the QCEW revision data that will be released on September 9 for Q4 and February of next year for this year. He believes there will be big negative revisions and that May-June will see an average further negative revision of 60K per month.
He also brought up the concept that many economists and Fed members have been speaking to. There is less demand in the labor market, but also less supply, so the breakeven of how many jobs need to be created to keep the unemployment rate stable has fallen. But he said that he has never seen the breakeven be a negative number, which he thinks we are seeing.
Waller thinks the labor market is continuing to weaken and pointed to the quit rate being at the lowest levels since 2010, business contacts telling him that they are delaying hiring due to uncertainty over tariffs and the threat of AI, and rising teen unemployment.
One of the most interesting things he covered was the response rates. There has been a lot of talk about the response rates being much lower than just a decade ago, causing inaccuracies in the data. The BLS allows firms to respond over a three month period. 10 years ago, the response rate was 95%, with 75% responding in the first month and 20% responding in the second and third month. Today, we are still getting the same overall response rate of 95%, but firms are reporting later. Today, there is only a 60% response in the first month and 35% over the second and third months. He argued that it doesn’t mean the data is worse or more unreliable, but because of the delay in responses, it leads to bigger revisions…which we have been seeing.
He also explained that bigger revisions can signal a turning or inflection point in the labor market and that he expects further weakening.
On inflation, Waller believes that factoring out tariffs, underlying inflation remains close to the Fed’s 2% target.
He also thinks the neutral Fed Funds Rate is 3%, and with the current Fed Funds Rate at 4.375%, implies the Fed is restrictive by 1.375% and has a lot of room to cut rates and still be somewhat restrictive.
Waller was in favor of a cut in July, and is even more confident the Fed should be cutting September 17. He believes the Fed should cut 25bp, not 50bp to catch up. According to Polymarket, Waller is the leading candidate for the next Fed chair at 34% and we believe he would be a good one, as he has the most experience out of any candidate on the Fed and he seems to really understand the economic data and economy.
News Next Week
Monday: Markets closed for Labor Day
Wednesday: JOLTS, Mortgage Apps
Thursday: ADP Employment Report, Initial Jobless Claims
Friday: BLS Jobs Report
As of now, the market is forecasting that the BLS Jobs report will show that 78K jobs were created in August and that the unemployment rate rose from 4.2% to 4.3%. Because the last reading was actually 4.248%, it won't take much to see 4.3% and there is a chance it could surprise the markets and rise to 4.4%. Once again, the revisions to the prior months could be a big part of the story and may lead to a negative June reading, which would be the first negative month from the BLS in almost 5 years.
Technical Analysis
Mortgage Bonds are trading in a wide range between support at 101.88 and overhead resistance at 102.23.
The 10-year is also trading in a wide range between resistance at 4.288% and 4.2%. Yields do look poised to test 4.20% again, and if that level is broken, the next stop is 4.13%. Next week’s Jobs data will be key, and if the reports come out weak, there is a good chance yields and rates can continue lower.
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