Consumers Spend as Inflation Remains Tame

Consumer disposable incomes rose 0.3% in June, after a slight downward revision to May. Personal consumption expenditures rose 0.2% after adjusting for inflation, following a slight upward revision in May.

In June, the saving rate was 8.1%, which is off from a peak of 8.8% in February. The higher saving rate has been viewed favorably as it suggests that consumers have something in the bank to weather a downturn, although the distribution of that saving remains concentrated in higher-income households.

A rise in spending on services and nondurable goods more than offset a drop in spending on big-ticket durables such as vehicles and furniture. The drop in big-ticket items followed outsized gains in May, which were boosted by an increase in incentives.

The Personal Consumption Expenditures (PCE) index, which is the Federal Reserve’s favored measure of inflation, came in slightly cooler than expected. The PCE index rose only 0.1% in June and held at 1.4% on a year-over-year basis. That is well below the Fed’s 2% target and one of the main reasons the Federal Open Market Committee (FOMC) is intent on cutting rates. Members would prefer to see a hotter economy with more wage gains and participation by a broader group of people. Tight labor markets are prompting employers to give people who were once overlooked a chance.

The core PCE (ex food and energy) rose 0.2% in June, the same as May and slightly below expectations. That put the year-over-year increase in the core PCE at 1.6%, up a tenth of one percent from May and still too cool for the Fed. In fact, there is a strong contingency at the Fed, including Chairman Jay Powell, who believe we should be overshooting on the 2% inflation target after missing it on the low side for so long. President Charlie Evans of the Chicago Fed has argued that a 2.25% inflation rate may now be appropriate before the FOMC needs to start worrying about the economy overheating.

Bottom Line
Today’s data confirm that the consumer bounced back in the second quarter and has a cushion to keep up that momentum this summer. The key will be confidence in younger households, which remains lagging. Today’s data also provides the FOMC with the rationale to cut rates a quarter percent, given the persistent miss on the inflation target.

Also today, historical revisions of the data were released; they were largest for 2018, which shows a big upward revision to income but not spending. Tax cuts were saved instead of spent. That partially reflects the composition of the tax cuts toward higher-income households, which tend to save more of what they take home in pay. That pushed up the saving rate a full one percent from an initial reading of 6.7% in 2018 to 7.7% last year.

Recent surveys of younger workers also suggest a creeping pessimism that could be prompting younger consumers to save more. A similar phenomenon occurred in Japan in the 1990s and cannot be fully discounted, given how hard millennials were hit by the financial crisis. They now believe they will do worse than their parents in terms of living standards. Rising government debts and deficits are exacerbating those concerns.

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