Personal Incomes Boosted by Tax Cuts and Bonuses

Fiscal stimulus that came from tax cuts and bonuses will make up for a weak first quarter and our forecast holds for four rate hikes in 2018.

Disposable personal income surged 0.9% in January, more than double the pace of December. Almost all of that acceleration in income growth was due to preliminary estimates that the Bureau of Economic Analysis (BEA) made to account for the tax cuts passed in December. The numbers included one-time bonuses, estimated at $30 billion, which will fall out of the data for February. The one-time bonuses accounted for less than 0.2% of total incomes. The data for the previous month were revised up slightly, underscoring that the economy ended 2017 on a firm footing. After adjusting for inflation, disposable incomes rose 0.6% for the month.

Personal consumption expenditures actually fell 0.1% after adjusting for inflation in the month of January; December data were revised up slightly. The weakness was heavily concentrated in durable goods, particularly vehicle sales, which accounted for the bulk of the decline in January. The surge in replacement demand during the fourth quarter was in response to hurricanes and fires; those sales borrowed from the start of this year. Worse-than-usual winter weather in parts of the South raised a hurdle for spending in January as many tourist destinations were actually forced to close for a portion of the month.

Some of the losses will be recouped later in this quarter. We may have to wait until March when we should see spending associated with tax refunds and an early Easter show up in the data. Concerns about fraudulent tax refunds following the hacking of credit bureau Equifax last year has delayed tax refunds for many early filers.

The personal consumption expenditures (PCE) deflator, the most accurate measure of inflation, rose 0.4% in January; that was four times the pace of December. Monthly gains were driven by a surge in energy prices and a strong increase in the price of clothing, which showed up in the CPI data as well. Energy prices have abated from the highs we saw late last year. Retailers were much more aggressive in managing their inventories during the holiday season than in the past, which meant fewer discounts in January. Year-over-year gains in the overall index held at 1.7%, the same as December.

The core PCE (nonfood and energy) deflator rose 0.3% in January, only slightly faster than in December. Year-over-year gains held at a 1.5% pace, still well below the Federal Reserve’s 2% target. The slow pace of inflation, however, is not expected to stop the Fed from raising rates again in March. The majority on the Fed feels that monetary policy remains too accommodative for an economy that is poised to accelerate after a winter lull.

The saving rate jumped to 3.2% in January after dipping to 2.5% in December. Much of that increase will dissipate when the effects of tax cuts and temporary bonuses work their way through the economy. The low rate of saving in late 2017 is expected to return, given the increased access to credit card debt and expansion in the shadow finance system. This is an area that concerns Fed officials as they can’t fully track where lending is now occurring in the economy.

Bottom Line
Distortions to the January income and expenditures data will take time to play out. The first quarter of 2018 is coming in weaker than expected, in part due to unusually bad winter weather. That weakness will be quickly recouped with the fiscal stimulus we have in the pipeline. Given the expected acceleration, our forecast holds for four rate hikes in 2018.

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