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Spending Flatlines, Incomes Moderate, Inflation Edges Up

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Incomes after adjusting for taxes and inflation edged up 0.2% in February, one-third the pace of January. The results for January were boosted by a shift to account for tax cuts coming sooner than most households actually felt them. A spurt in one-time bonuses associated with changes in the tax code at the start of the year also contributed. [Those one-time bonuses in January covered less than 1% of the labor force and added an even smaller percentage of overall income generated during the month.]

That said, the data on February income gains were solid, driven by a more fundamental and potentially sustainable rise in wages and salaries. We also saw a surge in nonfarm proprietors’ incomes, largely from rental income. A shortage of entry-level single-family homes for sale is forcing many millennials to rent for longer than they expected. This is starting to push up rents again even in areas that suffered from overbuilding in recent years. The downside is that rent costs are eating further into discretionary spending for the youngest members of the labor force. Consumer outlays flatlined after adjusting for inflation in mid-February.

Those expecting a sharp bounceback in spending for March may be disappointed; whacky spring weather disrupted travel and forced many workers to stay home during the week that the Bureau of Labor Statistics (BLS) took its survey for the March employment report. The result will push real GDP growth even lower than we expected for the first quarter. It now looks like the economy slowed to a 1.5% pace in the first quarter, almost half of the revised 2.9% pace of the fourth quarter. The Commerce Department has had a problem accurately adjusting for the first quarter in the past. The result has left us with a sawtooth pattern to growth in the first half of the year, though we hoped that had been been corrected.

The personal consumption expenditure index (PCE) rose 0.2% in February, marking a slight slowdown from the month-to-month pace that we saw in January. A jump in energy prices and nondurable goods prices contributed to that rise. Year-over-year gains in the PCE index, which is more accurate than the CPI and the preferred measure of inflation for the Federal Reserve, edged up slightly to a 1.8% pace. The core PCE, the best indicator of momentum in prices moved up slightly on a year-over-year basis for February to a 1.6% pace. Those shifts bring the PCE slightly closer to the Fed’s target of 2%.

The real test for the Fed on inflation will come in April, when the March data is released. Fed officials have been fairly confident that the slowdown in inflation we saw in 2017 was due to transitory factors. The move to unlimited data plans for cell phones that began in early 2017 is expected to work its way out of the data by the March PCE report. If it does and inflation shows more underlying momentum, the Federal Open Market Committee (FOMC) will not raise rates at the June meeting. Then the committee members would likely increase the number of rate hikes they expect this year to four, up from three. Only one participant needs to change a forecast for that to occur. President Raphael Bostic of the Atlanta Federal Reserve Bank is a natural candidate; he recently argued that risks to his forecast for growth are to the upside which could pressure the FOMC to raise rates faster than it currently expects for 2018.

Finally, the saving rate edged up from a 3.2% pace in January to 3.4% in February. That’s higher than the saving rate at the end of 2017, which was the lowest since the height of the housing bubble in 2005. A large part of that is because of the way tax cuts are recorded. The saving rate is likely to fall again as we move into the second quarter. We need to see a very large increase in employment and wages to get consumers out of the debt they have once again taken on.

Bottom Line: Data for the first quarter is proving to be stubbornly weak once again. It has been a false indicator for overall economic growth for many years now and may be again for 2018. Higher borrowing rates for consumers, however, raise a red flag for the outlook in 2019, especially in light of higher interest rates and interest expense expected over that period.

About the author
Diane Swonk Diane Swonk
Chief economist
Twitter: @DianeSwonk


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