Personal spending grows hot in July as inflation stabilizes

REAL ECONOMY BLOG | August 31, 2023

Authored by RSM US LLP

American consumers remained in a position of strength on spending and income growth this summer as inflation stabilized further and the labor market stayed resilient.

July’s personal spending surged by 0.8% while personal income grew by 0.2%, the Bureau of Economic Analysis reported on Thursday. With the Federal Reserve’s key inflation metric, the personal consumption expenditures index, running at 0.2% monthly, inflation-adjusted spending  increased by 0.6% while income was unchanged.

Core monthly inflation excluding food and energy grew by 0.2%, while the so-called super-core component that includes services less food, energy and housing rose by 0.46% on the month.

Besides inflation and the labor market, a significant contribution to the top-line growth in spending came from many one-time events this summer that spurred short-term impulse spending like the record-breaking Amazon Prime Day, the blockbuster films Barbie and Oppenheimer, known as “Barbenheimer,” and the national tours of Taylor Swift and Beyonce.

With more than $500 billion in excess savings left at the end of the second quarter, according to our estimate, there are plenty of reasons to expect consumers to be in a good shape through the remainder of the third quarter.

There has also been a psychological impact on spending as the headline inflation number normalizes as recession concerns ease. Consumers, feeling more secure with their jobs and income as the labor market stays tight, are not likely to pull back on their spending prematurely.

The savings rate dropped sharply to 3.5% from 4.3%, reaffirming a stronger-than-usual spending month.

We expect that the strength in consumer spending will be the biggest factor that drives gross domestic product growth this quarter above the long-term trend of 2%. Our estimate is now pointing to a 2.1% increase for the third quarter with risks to the upside.

That said, the “economic sky”—using the analogy from Fed Chairman Jerome Powell’s recent speech at Jackson Hole, Wyoming—will be much cloudier once the holiday shopping season begins.

We do not expect the strong spending momentum will last until Christmas. While that does not necessarily mean that there will be sharp declines in spending, there are key risks that will most likely turn tailwinds into headwinds.

Rapid disinflation should not continue as inflation becomes stickier, hovering around 3% and above.

July’s annual PCE inflation increased to 3.3% from 3.0%, while annual core inflation that excludes food and energy grew by 4.2%, up from 4.1%. The key policy metric—super core inflation–came in at 4.69%.

Also, we won’t be able to rely on one-time events like those that occurred this summer to support the same level of spending. In addition, the early holiday shopping that took place in the previous two years around September and October should be a seasonal quirk that most likely adds downside risks to the spending data in the fourth quarter.

With monetary policy not loosening anytime soon, excess savings should fall close to depleted territory if low savings rates continue.

And finally, there are increasing signs that the labor market is cooling to a more balanced state that should soften wage growth toward the end of the year.

Policy implications

July’s robust spending data should not be an ingredient for another rate hike in September, given the uncertainties.

We believe the full impact of the Fed’s rate hikes still need another three to six months to be absorbed by the market; for this reason, we should expect more economic cooling to come.

With interest rates at 5.5% and underlying inflation running between 3% to 4%, we think monetary policy is restrictive enough to keep growth and inflation under control.

We have argued for some time that the next three to six months will be pivotal for the Fed as the economy cools; for this reason, it is even more important for the Fed to stay patient.

It is crucial that the Fed let the economy work itself out rather than add more shock with a rate increase, even a small one, as the once high-flying economy descends to the tarmac.

Inside the data

The increase in spending was broad-based in July. Spending volume on goods and services both posted solid increases, with goods spending rising by 0.9% and services spending increasing by 0.4%.

Spending on recreational goods led the goods category, increasing by 2.5%, while spending at restaurants and on financial services led the service category, both rising by 1.1%.

Personal income growth, at 0.3%, was slower than the previous month and came in below expectations. This reflected the decline in weekly worked hours observed in last month’s jobs report.

After adjusting for inflation and taxes, disposable income fell by 0.2% on the month, the first decline since July last year.

Regarding PCE inflation, it was not a surprise that prices rose most for transportation and recreational goods with the impact of summer spending and the one-time impulse spending. Financial service prices also rose sharply by 1.6% on the month.