Temporary Setback for Incomes

Personal disposable income fell 8.2% after adjusting for inflation in February. That only partially offset the modestly revised 11.1% surge in January. Much of the drop can be tied to the timing of the $600 stimulus checks, which hit consumer wallets in January. The polar vortex and electricity outages in the oil patch also took a toll on hours worked, which tempered employment-related gains in wages and salaries.

Brace for another surge in incomes for March when the third round of larger, $1400 stimulus checks was paid out at the same time employment appears to have surged. We are now expecting to see more than one million jobs created during March when the official data is released next week.

Personal consumption expenditures fell a more modest 1.2%, adjusting for inflation, after surging an upwardly revised 3% in January. The drop in spending on goods was much larger than the pullback in services. The pullback in services was tied to spending at restaurants and bars and was exacerbated by closures triggered by the unusually bad weather causing power outages in the oil patch and parts of the South. Spending at hospitals and on health care rose only slightly.

Those losses will be temporary because we know that travel and spending on services picked up substantially in response to the new round of stimulus checks and many states lifting their restrictions. Passengers at airports hit the highest level in over a year this month in response to spring break and a jump in the demand to travel by older adults who were fully vaccinated during the month.

There are signs of a fourth wave and a rise in hospitalizations tied to more contagious and potentially more lethal variants of the virus. That could dampen activity as we move into April, but there is little support for a major rollback in restrictions unless hospitals get overwhelmed again. The new variants have triggered a rise in hospitalizations of people under 50, while vaccinations have eased the risk of hospitalization or worse for those over 65. The pace of vaccinations is accelerating as more supply has come on line and resistance to taking vaccines has decreased.

The personal consumption expenditures (PCE) index, which is a more accurate measure of inflation than the CPI, rose 0.2% in February. A jump in prices at the gas pump drove those gains. We have also seen an uptick in prices tired to supply chain bottlenecks. Ships are waiting weeks to be unloaded at U.S. ports. The PCE index rose to 1.6% in February on a year-over-year basis compared to 1.4% in January. The core (excluding food and energy) PCE rose a tepid 0.1% in February. The core PCE slowed to 1.4% in February on a year over-year basis after rising 1.5% in January.

Those measures are still well below the Federal Reserve’s 2% inflation target but will not stay there for long. A sharp drop in many prices at the onset of the crisis in March 2020 makes year-on-year measures of inflation easier. We could exceed the 3% threshold on year-over-year measures in March. We also could see a flare in prices due to pent-up demand and supply chain bottlenecks.

Vehicle production has already suffered a setback due to a shortage of computer chips out of Taiwan, which is further pushing up prices. Airfares, hotel room rates and rental car rates have all begun to move up as the pent-up demand for travel is beginning to be unleashed.

The Federal Reserve has said that it would “look through” any flare in prices as pent-up demand for services is unleashed. It is easier to shut down capacity than ramp it up; the Fed does not want to get in the way of a rapid recovery in the economy because of what officials see as a temporary flare in inflation.

Bottom Line
The recession due to COVID is the deepest on record, though it technically ended almost as fast as it began. The trough in activity occurred in April 2020. Vaccinations and additional stimulus have provided much-needed adrenaline shots to the recovery so the weakness we saw in February will be short-lived.

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