Incomes & Spending Cool, Prices Flare

Personal disposable incomes plummeted 15.1% in April after adjusting for inflation, partially retracing the record-breaking gain of 22.7% in March. A waning of stimulus checks and slowdown in employment accounted for the drop.

Real disposable incomes still gained a stunning 9% from the precrisis peak in February 2020. Unprecedented emergency aid and stimulus helped to fill the hole left by job losses, albeit unevenly. Some one in four women and one in five adults were still lagging their precrisis status, according to a recent survey of financial conditions in April.

Personal consumption expenditures slipped 0.1% after adjusting for inflation in April. That compares to a 4.1% increase in March. Increased spending on services only partially offset a drop in spending on goods. Vehicles were an outlier, but price hikes eroded some of the gains on an inflation-adjusted basis. Rental car companies are now competing with consumers to replenish their fleets.

Real consumer spending rose 1.8% from a precrisis peak in February 2020. Look for that to accelerate over the next several months as pent-up demand in services is unleashed.

The personal consumption expenditure (PCE) index added 0.6% from March to April and 3.6% from a year ago. That marks the fastest annual increase since September 2008. April 2020 marked the trough of the COVID recession when lockdowns put the economy into a deep freeze; employment and many prices plummeted. The April acceleration in prices was broad-based in both goods and services as consumers continued to buy goods while ramping up spending on services; the backlog at doctor and dental offices mounted and with that came price hikes.

Core PCE, which strips out volatile food and energy prices, increased at 0.7% during the month and jumped 3.1% from a year ago. That makes the fastest pace of core inflation since July 1992, but still well below the 4.2% jump in the CPI measure of inflation for the month. The PCE better captures the tradeoffs that we tend to see when consumers opt to buy pasta instead of beef when the price of beef soars. This keeps the PCE somewhat cooler than the CPI measure of inflation, which does not allow for shifts in how consumers manage their monthly budgets.

The Federal Reserve has made it clear that officials believe many of the price hikes we are seeing are transitory. The magnitude of the recent increase was a surprise. The Fed will be watching for moderation in inflation pressures by year-end. Any signs that the surge in inflation tied to reopening the economy could be longer lasting could move up the timeline on rate hikes.

Most within the Fed do not expect to raise rates until 2024. We are expecting rate hikes to begin in 2023. Look for Fed Chairman Jay Powell to lay out a framework for tapering the Fed’s $120 billion per month in asset purchases by the Kansas City Fed’s Jackson Hole meeting in late August.

Bottom Line
The economy is reopening with a tailwind from pent-up demand and stimulus checks. Many producers on the goods side of the economy see the gains as transitory and have been either reluctant or unable to ramp up production. Most of the surge in prices should abate as consumers pivot from goods back into spending on services in the second half of the year. A more rapid and sustained acceleration in prices could test the Fed’s patience on rate hikes by year-end.

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