Child Tax Credit Buoys Incomes

Personal disposable incomes jumped 0.7% July after adjusting for inflation, buoyed by the first installment in the monthly child tax credit payments, strong job gains and an acceleration in wages, especially in low-wage jobs. Another catch-up payment came through for the child tax credit in August; current monthly payments are slated to end in December. This is helping to support spending today, notably on children. Measures of hunger, especially among children, dropped to the lowest level of the pandemic in July and August, according to the Household Pulse survey by the Census Bureau. Those gains came on the heels of modest upward revisions in the second quarter when stimulus checks combined with improvements in the labor market to boost incomes.

Personal consumption expenditures fell 0.1% after adjusting for inflation in July, despite the pickup in incomes. Solid gains in spending on services - everything from restaurants to travel, tourism and elective surgeries - were not enough to offset a sharp drop in spending on goods. Price hikes and shortages contributed to the downdraft in spending on services. Bottlenecks and disruptions in shipping due to the Delta virus left auto dealer lots empty and retailers without their usual summer inventories. The markdowns we usually see in July were much smaller this year because of the shortfall in retail inventories.

The saving rate rose to 9.6% in July after falling to 8.8% in June. That is the second-lowest level of the pandemic, but still well above the pre-pandemic level of about 7.5%. The savings accrued by low-income households, however, will be the first to be depleted when enhanced unemployment benefits come to an end at the start of September.

The personal consumption expenditures (PCE) index, which more accurately tracks inflation than the CPI, rose 0.4% in July and jumped 4.2% from a year ago. That is another pandemic high for annual measures of inflation and the highest pace for overall inflation since 2008. The core PCE (excluding food and energy), which better predicts where inflation is going, increased 0.3% during the month, but picked up to a 3.6% pace compared to a year ago. That is the fastest pace since mid-1991 and another pandemic high.

The question is whether supply disruptions due to the Delta variant are greater than those to demand. If supply remains constrained more than demand, then we will suffer unwanted residual inflation in 2022. If it does not, then inventories could rebuild much faster than many expect in 2022, which could exert downward pressure on key prices.

Research done early in the pandemic revealed that fear is as much a deterrent to congregating as lockdowns. People pulled back, regardless of a county’s lockdown status, when fatalities increased. We were more resilient in spending behaviors during the three prior COVID waves.

The Delta variant is different. Contagion is worse, even among the vaccinated, with children getting hit harder than during previous waves. Schools that opened have been forced to close due to quarantines; districts with low vaccination rates among adults and no mask mandates have been hardest hit. This will likely have a larger impact on spending in August and September than it did in July. Earlier this month, consumer sentiment hit the lowest level since the onset of the pandemic in response to both inflation and Delta concerns.

This has left the Federal Reserve in a wait-and-see mode. Officials do not want to preemptively stamp out a boom that will dissipate on its own, but they risk chasing instead of preempting inflation. Given the millions without jobs who are scheduled to lose unemployment benefits by September 6, inflation is a more benign risk though neither outcome is ideal.

Bottom Line
Consumers continued to pivot away from goods to spending on services in July. Shortages and steep price hikes accelerated that shift. It is unclear if we will see a shift back into spending on goods if consumers pull back in their spending on services in response to the Delta variant; the fiscal stimulus that enabled us to weather earlier waves is waning.

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