Consumers Remain Resilient

Personal consumption expenditures jumped 0.9% in April, after surging an upwardly revised 1.4% in March. Spending was up 0.7% after adjusting for inflation. Vehicle sales picked up from the supply-constrained levels of March, while spending on services remained buoyant. The latter includes spending on everything from travel and tourism to medical services. Elective surgeries and routine medical tests that were delayed by the pandemic are now backlogged.

The weakness was in spending on goods relative to a year ago. Spending on both durable and nondurable goods fell after adjusting for inflation on a year-over-year basis, while spending on services picked up. This is one of many reasons Big Box discounters found themselves with unwanted inventories in recent months.

Personal disposable incomes increased at a slower 0.3% pace in April but flatlined after adjusting for inflation. Gains were supported by another solid month of employment but momentum slowed from the pace of the first quarter. Tax refunds, which usually hit consumer wallets earlier in the year, were delayed this year due to acute staffing shortages at the IRS.

The personal savings rate plunged to 4.4% during the month, the lowest level since September 2008, which marked the onset of the global financial crisis. High- and middle-income households still have some savings amassed. Households in the bottom quintile have now tapped what little they had in excess reserves and are struggling to make ends meet. Inequality is worsening.

The personal consumption expenditures (PCE) index rose a more measured 0.2% in April, a deceleration from the red hot 0.9% pace of March. The PCE index jumped 6.3% from a year ago in April, a slight cooling from a pandemic peak of 6.6% in March.

A modest drop in prices at the gas pump helped to alleviate the upward pressure on overall inflation; those price declines have since reversed and are likely to worsen over the summer, given constraints in refining capacity. Food prices are expected to move even higher with Russia threatening a blockade in the Black Sea on agricultural exports from Ukraine. The humanitarian crisis triggered by the war is worsening by the day.

The core (ex food and energy) PCE index edged 0.3% higher during the month. That translates to a 4.9% increase from a year ago in April, slightly cooler than the 5.2% we saw in March.

The slowdown in the overall and core PCE index was much more dramatic than we saw for the CPI index in April. The two measures differ in many ways; the weights in the PCE index move to reflect shifts in what consumers buy each month, while the CPI does not. The PCE index gets spending data directly from firms.

The index on airfares revealed a particularly large divergence due to that discrepancy this month. The PCE index relies on airline revenues per mile traveled to track airfares. The CPI compares airfares across a sample of routes. The former rose at a single-digit rate in April, while the latter surged at a strong double-digit rate. That discrepancy between measures was then amplified by a surge in travel over the spring break holiday, which was delayed until April because of the later-than-usual timing of the Easter holiday.

Many have touted March as the peak in inflation and are looking for inflation to cool from here. We are not as convinced given the risks we still face due to the war in Ukraine and lockdowns in China. Either way, it is important to note that any cooling we see will have a high floor. Both the overall and core PCE indices remain well above the Federal Reserve’s 2% target.

The persistence of inflation has forced the Fed to act much more aggressively on rate hikes. The minutes of the last FOMC meeting revealed a consensus within the Fed to raise rates by another half percent again at the June and July meetings. That is in addition to reductions in the Fed’s balance sheet, which is now shrinking at twice the pace the Fed allowed it to shrink in 2018. The result is the most rapid tightening of credit conditions since the 1980s.

Bottom Line
Consumer spending remained resilient in April. That is a double-edged sword as those gains are creating a floor for how much inflation can moderate on its own. In response, the Fed will have to more aggressively rein in demand to align with a supply-constrained economy. It is notable that the Fed has given up on waiting for supply chain problems to dissipate. It is in this way that the Fed has attempted to avert rather than repeat the mistakes of the 1970s.

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