American consumers continued to spend more in April as inflation showed signs of relief. The combination of higher incomes, excess savings and lower energy prices helped to alleviate some of the recent recession concerns.

On top of that, the advanced goods trade deficit improved significantly on the month, down 18.9%—another upside surprise for economic growth in the second quarter. The trade deficit was an important factor causing the economy to contract last quarter.

But inflation headwinds won’t go away anytime soon with energy prices picking up again in May and supply-chain issues likely to last well into next year because of the war in Ukraine and lockdowns in China.

We expect spending to slow down yet remain in positive territory as service spending continues to recover during the summer and consumers draw down the more than $2 trillion in excess savings they built up during the pandemic.

Personal spending rose by 0.9% in April, and by 0.7% after adjusting for inflation. The personal consumption expenditure price index, which is the Fed’s key inflation gauge, increased by 0.2% month-over-month.

The rotation in spending from goods to services slowed in April. Goods spending was up by 1.0% while service spending was up by 0.5%.

There is a lot of room left for such a shift in spending to continue as goods spending remained above the pre-pandemic trend and service spending stayed below the pre-pandemic trend.

While stronger demand for services will push inflation in services higher, most of the price gains in the service sector will most likely be offset by lower goods inflation as demand for goods moderates.

It was goods inflation, especially in cars, that pushed inflation to a multidecade high, along with food and energy prices.

That said, the shelter subcomponent, which is part of services, remains a sticky contributor to overall inflation. The bright spot is that the weight of shelter in the personal consumption expenditures price index is smaller than in the consumer price index because of measurement differences.

Solid growth in personal income at 0.4% helped consumers absorb some inflationary pressures. After adjusting for inflation, income grew by 0.2%.

With COVID-19 cases far below last winter’s peak, Americans have begun to draw down their excess savings. Savings rates in April fell to 4.4% from 5.0% previously. That marked the fourth month in a row that saving rates stayed below the pre-pandemic average rate of 7.4%.

Has inflation peaked?

The Fed’s main gauge for inflation—the PCE price index—showed signs of relief in April as the headline year-over-year inflation figure fell to 6.3% from 6.6% in the prior month. The core inflation figure that excludes food and energy prices also dropped, to 4.9% from 5.2% previously. Month over month, April’s inflation was 0.2% and core inflation was 0.3%.

Because of comparisons to a year ago, when inflation began to increase, the headline year-over-year inflation number most likely peaked in March. But that does not mean we are out of the woods yet. Inflation remains significantly above the Federal Reserve’s 2% target rate and will stay sticky through the rest of the year.

With energy prices picking up in May and no indication of any easing in food prices, May’s inflation reading will most likely heat up on a month-over-month basis—a more useful indicator than the year-over-year series.

The takeaway

Even if the worst has passed, the Fed will stay on course with its aggressive policy of two 50-basis point increases in June and July, together with offloading its asset holdings starting in June. Given the slightly less hawkish tone in May’s meeting minutes, a potential pause in rate hikes after the July meeting might be on the table if the economy slows sharply.