Spending stayed robust in September as inflation steadied

REAL ECONOMY BLOG | October 27, 2023

Authored by RSM US LLP

The U.S. economy maintained its momentum in September with personal spending that was stronger than forecasted. But even with the booming consumer demand, inflation ticked up only slightly, driven largely by energy and travel service prices.

Spending rose by 0.7% on the month, while the personal consumption expenditures index—the Federal Reserve’s key inflation metric—increased by 0.4%, the same as August. After adjusting for inflation, spending rose by a healthy 0.4%, according to data released by the Bureau of Economic Analysis on Friday. Core inflation rose by 0.3% from a month ago.

The data suggested an economy that has been running strong but not hot—more reason to expect a soft landing instead of a recession as the economy cools down. The final quarter of the year, though, will face more challenges than the previous one.

American consumers have proven to be far more resilient than expected, bolstered by $400 billion to $1.3 trillion in excess savings in our estimate.

With consumers not being afraid of reaching into their savings to keep spending, the risk of a pullback in the fourth quarter should be insignificant. The savings rate in September was 3.4%, sharply lower than the 4.0% rate in August and 5.3% in May.

We expect spending growth to be much slower in the last three months of the year compared to the third quarter, yet solid enough to keep consumption afloat.

The Federal Reserve, taking this week’s data together with its outlook for the fourth quarter, should stay firm on its interest rate path and hold rates steady for the rest of the year.

That should be restrictive enough to keep inflation from running hotter than desired while providing some much-needed certainty to the financial system, which has recently had increasing volatility.

Underlying inflation has been falling in line with the Fed’s 2% target. Core inflation, which excludes the more volatile categories of food and energy, was running at 2.4% on a three-month moving annualized pace, not far from the Fed’s target.

We should expect more relief as shelter prices tick down further following the frothy housing market of the past year.

Another reason to expect the Fed to hold rates steady is that even though job gains remain robust, total personal income after adjusting for inflation and taxes has been declining for four straight months.

Real disposable income fell by 0.1% in September, reflecting slower wage growth and fewer hours worked. If our prediction that the labor market will continue to cool down in the final quarter turns out to be true, we should see income to be less of a factor in bolstering spending.

The takeaway

Friday’s data on spending and income, together with recent data on gross domestic product, has pointed to a booming economy that should rebut any speculation for an imminent recession.

The next quarter, however, will be a pivotal one that should provide more clarity for whether we will be able to skirt a hard landing or not, given the many headwinds in the economy. We remain comfortable with our call for a soft landing as the base case, with a nontrivial 40% risk of a recession going into the holiday season.