American consumers continue to spend despite sticky inflation

REAL ECONOMY BLOG | April 26, 2024

Authored by RSM US LLP

Spending remained strong in March on the heels of robust income growth despite sticky inflation, according to Commerce Department data released on Friday.

The data pointed to the underlying strength of the economy and provided a rebuttal of sorts to the disappointing gross domestic product figure released on Thursday, which caused a negative market reaction even though domestic final sales and consumption were robust.

In Friday’s report, the Federal Reserve’s preferred metric for inflation, the personal consumption expenditures index, was unchanged at 0.3% on the month.

The core PCE index, which excludes the more volatile food and energy components, also came in unchanged at 0.3% on the month, though the year-ago readings were higher than expected at 2.7% for the overall figure and 2.8% for the core number.

The important component in the PCE data is housing, which did not decline as expected and remains a headache for the Fed as it tries to bring the inflation rate down to its target of 2%. But we should expect significant disinflation from housing as a number of indicators suggest, starting in the second quarter.

According to our estimate, housing inflation will most likely be cut in half, bringing overall inflation down toward to the 2% target. But with the Federal Reserve unlikely to change its policy until it has complete data for the second quarter, we think the probability of a rate cut in June or even July is now greatly diminished. Our base case is pointing toward one cut in September and another one in the fourth quarter.

Inside the data

Personal spending grew by 0.8% in March, and by 0.5% after adjusting for inflation, according to Friday’s data. February’s number for inflation-adjusted spending was revised upwardly, also to 0.5% from 0.4% earlier.

Spending on goods was a bright spot in March, rising by 1.1% on an inflation-adjusted basis compared with an increase of 0.2% for services.

Personal income growth increased to 0.5% from 0.3% earlier, reflecting a continuing strong labor market that resulted in robust compensation growth. After adjusting for inflation, disposable income also rebounded, rising by 0.2% after dropping by 0.1% in February.

The savings rate dropped to 3.2% the lowest level since October 2022, a point of concern that suggests consumers might have to reach deeper into their savings to maintain their spending.

Based on our estimate, the excess savings built up during the pandemic will most likely be depleted by the summer, keeping a ceiling to overall spending toward the end of the year especially when no fiscal or monetary supports are available.

The takeaway

Friday’s inflation report showed that the economy remains strong and suggests that the market overreacted to Thursday’s GDP report. The notion that the economy is facing a period of stagflation after one GDP report does not have any merit.

We continue to believe that, despite three months of resurgent inflation, the Fed should cut rates this year, even if it’s later. Just as the recent rising inflation has prompted us to recalibrate our forecast for rate cuts, so too could three or more months of disinflation prompt a similar recalibration, but in the opposite direction.