Consumers Pulled Back in December

Personal disposable incomes edged up only 0.2% after adjusting for inflation in December. That follows two months of contractions in October and November; the data for the previous two months were revised down. Nearly two-thirds of the negligible gain in December can be attributed to enhancements to unemployment insurance (UI) benefits and stimulus checks received during the last few days of the month. The remainder was due to a slight increase in hiring for high-wage workers, which contrasted with a devastating blow to low-wage workers in the leisure and hospitality industry. We lost about 450,000 jobs, mostly in restaurants and bars, last month.

Personal consumption expenditures (PCE) fell by 0.6% after adjusting for inflation, marking the second pullback by consumers in a row. Retail sales, which do not include spending on most services, dropped for the third month in a row in December. Data for October and November were also revised lower and suggest that the economy ended the year even weaker than indicated by the real GDP report released yesterday. It now appears that growth slowed to 3.2% in the fourth quarter, 0.8% below the 4% reported yesterday.

The pullback in consumer spending was broad-based, hitting all categories. Losses were largest in nondurable goods, which include everything from food to clothing and services. The retail sales data, which does not include most spending on services, fell for all three months of the fourth quarter. Restrictions on dining out and going to bars and gyms went back into effect during the month as COVID cases overwhelmed many hospitals; some were forced to ration care.

Sadly, spending at grocery and beverage stores fell sharply during the month. Some of that reflects smaller holiday celebrations; the remainder reflects hunger. Demand at food banks surged during the holiday season as what was left of earlier UI benefits and stimulus payments evaporated.

Thankfully, the most recent aid package was passed. Preliminary data suggest a good portion has been spent; debit and credit card receipts point to spending on groceries and takeout, which rose during the first two weeks of January. That is providing support for struggling restaurant owners and their workers who have been hit hardest by layoffs.

The PCE price deflator, a more accurate measure of inflation than CPI, jumped 0.4% during the month. An outsized 4.2% monthly jump in energy prices accounted for a portion of those gains. Food prices also edged higher after retreating a bit in November. The PCE index rose 1.3% from a year ago, which is still well below the Federal Reserve's target of 2% for inflation but marks a slight acceleration from the 1.1% gain in November. The hard part is the outsized role that inflation in food prices has played for those struggling the most to feed and shelter their families.

The core PCE index, which strips out the volatile food and energy components, rose 0.3% in December. The core PCE was up 1.5% from a year ago during the month, which is still tepid but marks a slight acceleration from the 1.4% pace we saw in November.

Fed Chairman Jay Powell has gone out of his way to warn that the year-over-year measures of inflation will jump as we get into 2021. Inflation measures this spring could look at first glance particularly “hot.” But, and this is important, the bulk of that jump in inflation measures will be driven by a sharp drop in price levels at the onset of the crisis last year, not an acceleration in prices today. They reflect a change in the base from which we measure inflation not the trajectory of inflation and will quickly play out.

The Fed has vowed to look through those increases and continue to provide support for an economy that will still be struggling to reopen and recover. Powell has been clear that the Fed is much more nuanced in its views of inflation that it was in the past and less tied to hard numerical rules. They are even willing to push for an overshoot in inflation if that allows for a bigger drop in unemployment and wage gains for all workers. They are now defining full employment much more broadly than they did in the past, and including measures of unemployment and participation in the labor force across race and gender when they assess the overall health of the labor market.

This is a trend that Treasury Secretary Janet Yellen started during her tenure as Fed Chair. Powell has taken the concept of “inclusive” full employment to a whole new level.

Bottom Line
The economy slowed and lost some ground as we closed out 2020. The first quarter is poised to be even weaker. Technically, some will argue we are in a recovery, but this is a setback and the hole that COVID dug is still large. The data also reveal just how critical aid is in sustaining even modest growth given the course of the virus and progress in the pace of vaccinations. (We are still chasing instead of front running a virus that is mutating.)

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