Consumer Spending Rebounds in March

Personal Consumption Expenditures (PCE) surged 0.7% in March after adjusting for inflation. The increase marks the largest monthly rebound since the start of the recovery and is much needed after a sharp drop in spending in the December through February period. The PCE measure of consumer spending is a more broad-based measure of spending than retail sales because it includes spending on services. Gains were largest for big-ticket items including motor vehicles, which came back after declines at the start of the year.

Spending on services was led by outlays for health care. Spending on travel and more discretionary services was not as robust. A later-than-usual Easter and cancellations due to problems with Boeing’s 737 Max suggest that a portion of business and leisure travel was displaced to the second quarter.

Personal income net of taxes and Inflation actually contracted 0.2% in March. A shortfall in tax refunds likely exacerbated the weakness we saw in disposable income. Most households saw some sort of a tax cut in 2018, but most of what they saw showed up as lower withholdings and was spent in 2018 instead of early 2019. Households also saw a drop in personal interest and farm proprietors’ income in March. Diary and soybean farmers have been hit particularly hard by the administration's trade wars. Moreover, it is unclear whether the losses they have endured can be reversed with tariffs. Farm bankruptcies surged over the last year.

The saving rate dropped to 6.5% in March. That brings it back down close to the levels that we saw in November. The saving rate surged to 7.7% in December after a one-time bonus paid out by a Silicon Valley firm. Too much is often made of the saving rate, which is just the residual of income minus consumption in any given month. What has been notable is the lack of consumer debt we have this late in the economic cycle. We saw the saving rate drop precipitously in previous expansions when consumers cashed in on home equity lines of credit to support more spending than they could afford.

The PCE measure of inflation edged up 0.2% on higher energy prices. The PCE index rose from a tepid 1.3% year-over-year pace in February to 1.5% in March. That is still one half percent below the Federal Reserve’s target of 2%. The core PCE, which is even more closely watched by the Fed as the best predictor of future inflation, moderated to a 1.6% pace. Some on the Fed have argued that they should cut rates if inflation gets stuck at a 1.5% pace. The Fed has yet to clarify how low it will allow inflation to drift before it reverses course and cuts rates again.

Bottom Line
The rebound in spending was welcome as it helps us to climb out of the hole we fell into at the turn of the year. Consumers will need to show continued robust gains in April in order to put a dent in the overhang of inventories we have accumulated.

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