Falling inflation and the Fed

A busy week in the markets made clear that corporate earnings are strong, economic data is supportive, and new Federal Reserve Chair Warsh is on the job.

Headline consumer prices fell 0.4% in June, thanks to a sharp drop in gasoline prices. This pushed the year-over-year increase in prices down, from 4.2% to 3.5%, as the underlying core rate also fell, from 2.9% to 2.6%. Prices of goods and services both fell, providing consumers some relief, but recent moves higher in crude oil prices may undo some of this improvement.

Second quarter earnings at big banks were quite strong, driven by strong investment banking and advisory services. Animal spirits were evident, and importantly, bankers did not flag worries about consumer credit quality performance.

New Fed Chair Warsh testified before Congress for the first time as Chair, and he reiterated his confirmation testimony that the Fed takes seriously its job to get inflation down to the Fed’s 2% target. A notable clarification from his earlier comments was that Warsh said that changes to the Fed’s balance sheet would be pursued in a deliberate and well-publicized manner, calming some concerns that he wanted more rapid changes that could be disruptive. Warsh said that the Fed takes seriously both parts of its full employment and stable price mandate, but he admitted that the labor markets look to be in pretty good balance now, allowing more focus on the inflation front. One question left unanswered is what he would do if both parts of the mandate were offsides.

Weekly jobless claims surprisingly fell from 216,000 to 208,000, continuing just below their average over the last nearly five years, and providing additional confidence that the labor market is stable. This stability feeds into resilient consumer confidence, which, according to the University of Michigan consumer sentiment survey, increased in July as gasoline prices and inflation expectations fell. A confident consumer spends, and in June, headline retail sales rose 0.2%, held down by falling gasoline prices, but boosted by auto sales and likely helped by Amazon Prime Day and perhaps enthusiasm for the global soccer tournament. All told, consumer spending should boost second-quarter GDP.