Upside Surprise in Income and Spending Data

Personal consumption expenditures jumped an inflation-adjusted 0.4% in October, four times the downwardly revised pace of September. Gains were driven by a pickup in spending on prescription drugs and cooler-than-usual October temperatures across the country. The increase in spending on utilities was a primary driver of spending gains in services. We continued to see solid gains in food service and accommodation, which supports our prediction that travel will be especially strong this holiday season. Spending on clothing has picked up for both men and women in recent months after being nearly dormant for much of the expansion.

Disposable incomes rose 0.3% after adjusting for inflation in October, three times the tepid 0.1% pace in September and a bit slower than the growth in spending. Gains were broad-based with a nice improvement in employment buoying growth in wages and salaries for the month. Farm income rose following implementation of subsidies after tariffs and reciprocal penalties by our trading partners. Unfortunately, the subsidies didn’t take effect soon enough to stave off a jump in bankruptcies and loan defaults in the agricultural sector.

The personal saving rate edged down to 6.2%, one full percentage drop from the average of the first quarter. That raises warning flags about the consumer’s ability to keep spending at a robust pace during the holiday season and into 2019 even as a quirk in how the government accounted for the 2018 tax cut exacerbated the drop in saving in October.

I am concerned about the toll that a surge in tariffs could have on consumer demand going forward. The strong dollar has helped blunt the effect of tariffs, most notably on goods from China. We are hoping but not convinced that the administration will hit the pause button on tariffs following scheduled meetings with China at the G20 later this week. Our forecast still has tariffs on all Chinese goods rising to 25% by the start of 2019.

The personal consumption expenditures (PCE) price index rose 0.2% in October and held at the Federal Reserve’s desired target of a 2% increase from a year ago. We expect a drop in food and energy prices to further temper measures of overall inflation before year-end. The core PCE (excluding food and energy), which is better indicator of future inflation, edged up a tepid 0.1% in October but slipped to a 1.8% pace on a year-over-year basis. That will no doubt feed market expectations for more cautious rate hikes by the Fed next year. Much of the deceleration in the core may be traced to sharp deceleration in inflation in the service sector, which will likely reverse after the start of 2019. Services inflation is the most sensitive to wage increases, which are finally picking up. It also includes medical services, which are expected to rise as we move into the new year.

Bottom Line
The jump in consumer spending in October was encouraging for the holiday season but that needs to be tempered against the downward revisions to September’s data. The increase in incomes was more broad-based as subsidies finally helped farmers who have been slammed by tariffs.

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