Consumers End 2019 on Weak Note

Personal disposable income (excluding taxes) rose a tepid 0.2% in December after being revised down for the previous two months. After adjusting for inflation, personal disposable income actually contracted during the last two months of the year.

Part of the slowdown in income growth could be attributed to a drop in farm subsidies, which spiked in response to the trade war. Farm subsidies due to the trade conflict with China far exceeded the bailout of the auto industry during the height of the financial crisis in 2008-09. Growth in wages and salaries slowed during the month but are holding up much better than overall income growth.

Personal consumption expenditures rose only 0.1% on an inflation-adjusted basis and after being revised down on net for the previous two months. The weakness was concentrated in spending on big-ticket durable goods, which are driven by vehicle sales. Spending on services, which spans health care to travel, slowed a bit but not as dramatically as spending on big-ticket items.

The personal consumption expenditures (PCE) index, which tracks consumer inflation more accurately than the CPI, rose 0.3% in December. A rise in energy prices offset a drop in durable goods prices. The PCE edged up slightly to 1.6% on a year-over-year basis. The core PCE index (excluding food and energy prices), the best predictor of future inflation, rose 0.2% during the month. The PCE core index also edged up a tick to 1.6% for the month. Both indices remain well below the Federal Reserve’s target of 2%.

The Fed is betting that year-over-year measures of inflation will rise in the months to come. A slowdown in inflation in early 2019 makes year-on-year comparisons easier to meet. We expect that a shortfall in inflation and wage growth, coupled with a need to offset weakness associated with the coronavirus, will force the Fed to cut rates at least once again in 2020.

Separately, consumer attitudes improved across measures in January. Both consumer confidence and the index of consumer sentiment jumped to the highest levels in months. Those gains were registered before fears and flight cancellations associated with the coronavirus set in. That suggests consumer spending should hold up in January but could show some weakness in February.

Bottom Line
Consumer spending slowed fairly significantly in the fourth quarter and could suffer additional weakness in the first quarter as the effects of the coronavirus offset an improvement in consumer attitudes. Our forecast for a slowdown in growth during the first quarter holds.

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