Incomes Contract, Spending Bounces Back and Prices Decelerate

Personal disposable incomes fell 5% after adjusting for inflation in May. That loss was in line with expectations, given the extraordinary support provided to incomes via stimulus payments and extended unemployment benefits. Timing was an issue as the Bureau of Economic Analysis (BEA) was forced to make estimates for April and May unemployment benefits. Many of those benefits were booked as income in April, even though they didn’t really begin to show up in checking accounts in full until May or later; many people are still waiting for their first checks. The BEA had a note in its calculations admitting the difficulty of timing the payments, given the low response rate to their surveys and delayed access to source data. The CARES Act did not go into effect until late March. Many states are still playing catch-up with the actual payments. The BEA has better data from the Treasury department on the timing and allocation of stimulus checks, which were funded by the federal government.

Personal consumption expenditures surged at an inflation-adjusted pace of 8.1% pace in May following an upwardly revised, 12.2% contraction in April. The bounceback in May reflected the lifting of state-mandated lockdowns and a resumption of consumer spending. Gains were concentrated in big-ticket durable goods as those who were not out of work used their stimulus checks to buy vehicles. Others used their saving from cancelling vacations on big-ticket items, including home repairs and remodeling. Spending on nondurable goods, the only place we saw spending in the month of April, showed up in smaller gains on food services and clothing as restaurants and stores reopened. Spending on services was concentrated in health care, on everything from elective surgeries to physicians and dentists as medical offices opened back up. We saw some spending on accommodation when people mostly drove to destinations over the Memorial Day holiday.

The high frequency data on restaurant and hotel bookings suggest that those improvements continued through mid-June, then did a U-turn as the pace of infections spiked in new hot spots in states that opened before the CDC guidelines were met. That will not dampen overall spending gains in late June and over the critical Fourth of July holiday. Look for gains to be extremely regionalized as areas that succeeded in bending the curve on infections see new cases and states that reversed course pay a price in hospitalizations and infections.

Notable in the new data on infections is the absence of older, more vulnerable parts of the population. The surge is being driven by young people who are less risk averse in their behaviors. This, coupled with the fear of infection more broadly, will put a damper on our ability to recover fully before a vaccine is available. Even once there is a vaccine, we will have to do a lot to convince people it is safe. There is much more skepticism about taking a vaccine in the U.S. relative to other parts of the world.

The saving rate fell to 23.2% in May, after hitting a record high of 32.2% in April. Recent analysis of checking account data suggests that low-wage households increased their saving when their stimulus and unemployment checks came in, more than higher wage households did. This is the opposite of what we usually see and underlines the level of support that the government provided for workers who were unable to work during lockdowns. We also know that those workers spend a much higher percentage of their incomes on necessities. Delays in unemployment benefits forced many to skip rent in April and line up at food banks. Fear of additional layoffs, added to reduced hours for those who could return to work, may have prompted some households to hold back on spending in May. Many people are still unaware that the enhanced benefits could expire entirely at the end of July.

Separately, the personal consumption and expenditures (PCE) index rose a negligible 0.1% after falling in March and April. A drop in energy prices offset modest increases in durable goods prices and services in May. The PCE index is now tracking only 0.5% above a year ago. That is the weakest performance since December 2015, when oil prices were plummeting. The core PCE, which the Federal Reserve targets, also increased by 0.1% during the month, but rose 1% on a year-over-year basis. That is the weakest annual gain in the core PCE since December 2010, when home prices were still plummeting.

Hence, the Fed’s willingness to pull out all stops to stimulate the economy via monetary policy and advocate for fiscal support; Fed officials are more worried about deflation than inflation in a world where COVID-19 is still highly infectious. The risk of deflation rises over the summer if Congress fails to extend unemployment benefits when they expire July 31. What was largely a supply shock could more rapidly become a demand shock.

Another unique attribute of this recession is how common cuts to nominal wages became in response to the onset of COVID. Companies cut wages in the hope of preserving cash for a transitory event. Those cuts could become more widespread and trigger layoffs, depending on the strength of the recovery over the summer. That would further dampen inflation.

The only offset to a deceleration in core inflation could be rising tariffs in response to the escalation of trade tensions with China and the European Union. Those would add insult to injury for consumers by further increasing the cost of imported goods.

Bottom Line
Spending rebounded as lockdowns were lifted but at a price: a resurgence in infections. That has already blunted the economic rebound in June, with people pulling back from spending in hotspots. Gains in consumer spending will likely remain much more regionalized and stronger in places where health officials were able to bend the curve on infections. The outlook is contingent upon the places that are doing better staying that way.

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