U.S. consumer spending experienced a robust increase in July, reinforcing the notion that the economy maintained its strength in the early part of the third quarter. This development has led to speculation that the Federal Reserve may reconsider a half-percentage-point interest rate cut next month, despite recent labor market challenges.

The Commerce Department’s report on Friday highlighted that prices rose moderately last month, which helped to curb inflation concerns. This came against the backdrop of a rise in the unemployment rate to a near three-year high of 4.3% in July, which had previously stoked fears of an impending recession. Financial markets and some economists had even considered the possibility of a 50-basis-point rate reduction in September.

Despite the uptick in unemployment, Fed Chair Jerome Powell signaled last week that a rate cut was likely, reflecting concerns over the labor market. However, some experts, like Conrad DeQuadros, senior economic advisor at Brean Capital, believe that the current consumer spending patterns do not justify a half-point cut. “This is not the kind of spending growth associated with recession,” DeQuadros remarked.

Consumer spending, a key driver of the U.S. economy, rose by 0.5% in July, following a 0.3% increase in June. This increase was in line with economists’ expectations, indicating that consumer confidence remained strong. After adjusting for inflation, spending increased by 0.4%, suggesting that the momentum from the second quarter, which contributed to a 3.0% annualized GDP growth rate, continued into the third quarter.

The overall economic growth rate stood at 1.4% in the January-March quarter, and the Atlanta Fed has since raised its third-quarter GDP growth estimate to 2.5% from 2.0%. The spending surge was broad-based, with consumers increasing their outlays on motor vehicles, housing, utilities, food, beverages, recreation, financial services, insurance, healthcare, and more.

While the labor market has slowed, it continues to support decent wage growth, which in turn underpins consumer spending. Personal income rose by 0.3% in July, matching June’s increase, and wages followed a similar upward trajectory.

However, the drop in the saving rate to 2.9%, the lowest level since June 2022, has sparked debate among economists. Some argue that the government may not fully account for income earned by undocumented immigrants, while others believe that households might be dipping into savings to sustain their spending, potentially jeopardizing future consumption. Still, another group views the decline as manageable, citing strong household balance sheets buoyed by rising house and stock prices.

Undocumented immigrants have also been linked to discrepancies in employment estimates, with the Labor Department’s Bureau of Labor Statistics suggesting that job gains were overstated by 68,000 per month in the 12 months through March. This discrepancy could imply that the saving rate is higher than currently reported, as noted by Bill Adams, chief economist at Comerica Bank.

The release of August’s employment report next Friday is expected to be a key determinant in the Fed’s decision on the size of the September rate cut. Meanwhile, inflation remains on track, with the personal consumption expenditures (PCE) price index rising 0.2% in July, maintaining the same pace as in June.

Economists like Pooja Sriram of Barclays believe that the data points to inflation aligning with the Fed’s 2% target. Sriram stated, “We maintain our baseline call for three Fed rate cuts this year,” reflecting a cautious yet optimistic outlook on the economic trajectory.

(Adapted from Investing.com)

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