Inflation Takes a Bite Out of Spending

Personal consumption expenditures rose a tepid 0.2% in February, after rebounding an upwardly revised 2.7% in January. Spending actually contracted by 0.4% after adjusting for the monthly surge in inflation. Spending on services partially offset a drop in spending on goods. Throughput at TSA checkpoints picked up along with walk-in and reservations at restaurants according to OpenTable data. Spending on health care got a lift from the return of elective surgeries, tests and medical procedures delayed by the Omicron wave.

Personal disposable incomes rose 0.4% in February, after essentially flatlining with the end of the child tax credit in January. Personal disposable incomes were -0.2% after adjusting for the rise in inflation. The saving rate edged up to 6.3%, slightly above the 6.1% pandemic low hit we hit in January. That is well below the 8.3% we saw in February 2020, before the onset of the pandemic and suggest that households are beginning to whittle away at the excess savings they amassed during the quarantines.

The personal consumption expenditure (PCE) deflator surged 0.6% in February and was up 6.4% from the year earlier. That is the hottest annual pace for the overall deflator since January 1982. It is worth noting that this was before the boost to commodity prices we saw after Russia invaded Ukraine.

The core PCE, which strips out the volatile food and energy sectors, and provides a better idea of where inflation is going, jumped 0.4% in February. That translates to a 5.4% annual gain, or the fastest pace since October 1982, and well above the Federal Reserve's 2% target on inflation.

Russia’s unprovoked invasion of UkraIne is expected to push inflation even higher this spring. Hence, the Federal Reserve’s push to simultaneously raise rates by one-half percent and begin the arduous process of reducing its balance sheet in May.

Reductions in the Fed’s balance sheet are expected to amplify the rise in short-term interest rates. The Fed hopes to reduce its balance sheet by $3 trillion over the next 3 years. That could easily add more than one percent to rate hikes.

Bottom Line
Consumers are only beginning to feel the crimp of inflation, which will continue to get worse before it gets better. The Fed is well aware of that and now ready to chill an overheating economy. Bundle up.

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