Inflation & Delta Variant Zap Incomes

Personal disposable incomes fell 0.3% after adjusting for inflation in August. That follows a solid 0.7% gain in inflation-adjusted incomes in July. Employment gains added to wages and salaries in August, but at a slower pace than in July; higher wages were wiped out by the rise in inflation during the month. Monthly child tax credit payments helped enhance income gains in August; they also dramatically reduced the incidence of families reporting missing meals since the increases were instituted in July.

Brace for another month of losses in income during September, both before and after adjusting for inflation. Expansions and the $300 per week supplements to unemployment insurance lapsed for more than six million workers in the first full week of the month alone.

Personal consumption expenditures rose 0.4% after adjusting for inflation. A sharp increase in spending on nondurable goods such as school supplies and clothing, restaurants and recreation, helped to temper a sharp drop in spending on big-ticket durable goods. Supply shortages have hit vehicle sales particularly hard and juiced the price of new vehicles. That comes on the heels of large downward revisions to consumer spending in July, which suggests that the consumer will be a major drag on the overall economy in the third quarter after driving gains in the second quarter.

Consumer attitudes regarding buying homes and big-ticket purchases such as vehicles have plummeted in recent months in response to the surge in prices. The rebound in services showed continued gains in medical services, but the suspension of elective surgeries in areas where hospitals were worst affected by the Delta variant were temporarily suspended. Treating COVID is not a moneymaking event for hospitals, while it has spurred quit rates of frontline personnel.

The saving rate fell to 9.4% in August, which marks the second time since the onset of this crisis that we have seen the saving rate in the single digits. We are expecting to see the saving rate return to pre-pandemic levels in the low 7% range by mid-2022. That is somewhat sooner than we previously expected and reflects the slowdown in hiring triggered by the Delta variant and the need to use more savings to cover the basics of food, shelter and gas.

The personal consumption expenditure (PCE) index, which the Federal Reserve targets for policy decisions, rose 0.4% in August, the same as July. The year-over-year measure of the PCE jumped to 4.3% from a year ago, the fastest pace since January 1991 when the first Gulf War in Iraq had begun. A sharp increase in energy prices was the largest single contributor to overall inflation in August, a trend that will continue in September and is undermining the ability of low-wage workers to commute to jobs farther from urban centers.

The core (ex-food and energy) PCE index, which tends to be the best predictor of where inflation is going, rose 0.3% in August. The year-over-year measure plateaued at 3.6% for the third month in a row. That is the hottest pace since the early 1990s and has increased the ranks of those on the Federal Reserve who are looking to hike rates in 2022 instead of 2023. However, two of the most recent resignations of regional presidents in the Fed system were among those looking to raise rates.

Bottom Line
Consumer spending held up better than expected in August, but coming from a weaker base. Preliminary data suggest that consumer spending picked up a bit on services late in September. That will not change the fact that consumer spending went from being a driver to a drag on overall growth in the third quarter. Inflation has a price. Overall GDP growth looks like it slowed to about a 3% pace during the quarter, less than half the 6.7% pace we saw in the second quarter.

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