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Incomes & Spending Fall, Inflation Flares

RFP
Personal disposable incomes fell another 2.8% after adjusting for inflation in May as the boost to incomes tied to stimulus checks paid in March continued to play out. Wages and salaries continued to recover with solid gains in employment during the month. The next round of stimulus will hit in July when middle- and low-income households receive monthly tax-credit checks for children. Those will end in December.

Consumer spending fell an inflation-adjusted 0.4% in May after being revised up for the month of April. A sharp drop in spending on big-ticket durables led overall losses. Supply constraints, long backlogs and price hikes took a toll on everything from vehicles to appliance and furniture sales. Spending on nondurable goods also declined as consumers continued to pivot toward spending on services. Many are still playing catch-up with doctor and dental visits delayed by the pandemic, while spending on travel and tourism is picking up. Las Vegas hotels reported being nearly fully booked for the Memorial Day holiday. Airport traffic at security checkpoints picked up last month. Gains in leisure travel have helped to offset business travel, which is still lagging.

The saving rate fell to 12.4% in May from 14.5% in April. That is the lowest level for the saving rate since before the onset of the pandemic in February 2020; the saving rate then was 8.3%. Stimulus checks, enhanced child tax credits, excess saving and continued gains in employment all suggest that consumer spending will remain well above the precrisis trend through the start of 2022.

The personal consumption expenditures (PCE) index, which more accurately measures inflation than the CPI, rose 0.4% in May from April, slightly less than expected. The PCE rose 3.9% on a year-over-year basis in May. That is the fastest annual pace of PCE inflation since August 2008. Gains were driven by a spike in prices of big-ticket durable goods.

The core PCE (excluding food and energy) rose 0.5% in May and jumped 3.1% from a year ago. That is the hottest core PCE measure since April 1992. A surge in used car prices accounted for the largest portion of the upward move in prices in the CPI in May and showed up in the PCE index as well. Look for goods inflation to abate and the upward pressure on service sector prices to pick up as bottlenecks are resolved and consumers pivot into spending on services over the summer months. Airfares, vacation and vehicle rentals are all rising in price after tanking at the onset of the pandemic.

Faster than expected inflation figures have made many within the ranks of the Federal Reserve more nervous about rate hikes. It is no coincidence that a majority of participants at the June FOMC meeting shifted forward their expectation for rate hikes to 2023 instead of 2024. A sizable number, seven out of 18, are now expecting to raise rates at least once in 2022. Debate over when to taper asset purchases is heating up with more participants pushing to taper the Fed’s $120 billion per month before year-end. Watch for a rise in dissent on policy decisions as we move into 2022. The ranks of regional Fed presidents pushing for a 2022 rate hike, and eligible to vote on policy, will increase from two to three next year.

Bottom Line
Consumers are shifting their focus from spending on goods to services, but the underlying trend for consumer spending remains red-hot. The result is showing up in prices. Many of the increases we are currently seeing will play out as we move into the summer months when the effect of a sharp drop in prices a year ago dissipates. The remainder will intensify debate within the Fed about when to taper asset purchases and hike rates.

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