With the second half of the year now well under way, data this week showed a fairly Goldilocks outcome for the U.S. economy. Growth momentum coming out of the first half of the year was broadly favorable, while at the same time, inflationary pressures are cooling. In financial markets, company earnings reports out this week were mixed on aggregate, with weakness among the large tech firms dragging the S&P 500 down by 0.9% on the week as of the time of writing. U.S. Treasury yields also fell modestly on Friday’s PCE inflation report as markets wait to hear from the Federal Reserve next week.

Starting the week off on Tuesday, June housing data showed that existing home sales fell sharply to end the second quarter, fully retracing the uptick seen in the first quarter. However, this has not translated into material price adjustments, as the median home sales price in June was only a half-step off its all-time high seen in the month prior. With expectations growing for lower interest rates in the second half of the year, it’s possible that some buyers are biding their time.

The decline in the housing market shaved a marginal amount off real GDP growth in the second quarter, but solid growth in consumption, business investment, and government spending pushed the quarterly annualized growth rate to 2.8%, up from 1.4% in the first quarter (Chart 1). Growth in final sales to private domestic purchasers (excluding government spending and private inventory adjustments) was unchanged relative to the first quarter, as stronger consumption was offset by weakness in the housing market. Looking ahead, we expect that growth will moderate through the second half of the year but remain near the long-run average as the Federal Reserve begins to lower rates in the coming months.

To that end, inflation data released on Friday was slightly mixed on aggregate. Although headline PCE inflation declined modestly, core PCE inflation on a year-on-year basis was unchanged owing to a marginal acceleration in core PCE ex. housing, which offset a deceleration in housing inflation. Nevertheless, with housing inflation expected to continue to moderate moving forward and annual core PCE ex. housing inflation still in-line with the Fed’s 2% target (Chart 2), this report will not likely sway the Fed’s confidence about disinflation progress to a great degree.

Looking ahead, on the one-year anniversary of the last time the Fed hiked rates, Chair Powell is expected to begin opening the door to the possibility of a near-term pivot to rate cuts during his press conference next week. Financial markets have fully priced in the first cut occurring in just under two months at the September meeting, with an additional 2-3 cuts expected by year-end. However, overall guidance from the Fed next week is expected to emphasize caution and flexibility. Given the flare up in inflation in the first quarter, the Fed is going to want to be quite confident that inflation will continue to move in the right direction. On the other side of the Fed’s dual mandate, the second-last employment report before the September meeting, out next Friday, will also be monitored closely to determine whether the deceleration in job growth in the second quarter carried into the third. 

Andrew Foran, Economist | 416-350-8927