US: Consumer spending higher as inflation accelerates

The personal consumption expenditures price index, which the Fed uses for its inflation target, increased by 1% compared to the previous month and has increased by 6.8% since June 2021. The annual increase was the largest in the last 40 years. Excluding food and energy, the price index rose more than forecast of 0.6%. Compared to a year ago, it increased by 4.8%. Purchases of goods and services, adjusted for changes in prices, rose 0.1% in June after a revised 0.3% decline a month ago. Spending on both services and goods rose further. The median forecasts were for no change in inflation-adjusted spending from the previous month and a 6.8% increase in the overall PCE price index from June 2021.

Consumer spending barely rose in June after falling the previous month, highlighting how decades of high inflation have eroded Americans’ paychecks and softened demand. The share of basic necessities such as food and gasoline in the consumer basket has risen sharply recently, in part because inflation has forced Americans to spend more on necessities.

If we look at the sub-items; Non-inflation-adjusted spending increased by 1.1% compared to the previous month, while personal income increased by 0.6% in the second month. The growth in nominal monthly expenditures was driven by the increase in gasoline prices and the increase in non-durable consumer goods. While sales rose in nominal terms, real spending fell as inflation increased, especially at the gas pump and grocery store. The increase in service spending was supported by strong travel activity.

While indicators such as personal income, which the National Bureau of Economic Research assesses in relation to a recession, do not indicate that we are in a recession, other recent data indicate that the economy is rapidly losing momentum. After all, inflation is the best predictor of what the Fed will do. The Fed’s preferred indicator of inflation shows faster inflation on a headline and core basis two weeks after the CPI was announced. June personal spending data, a day after the 2Q22 GDP report, is more positive about the intra-quarter growth trajectory. Increasing spending on services is essential to compensate for the falling demand for goods. Durable goods purchases are falling as consumers spend money on more expensive essentials and return to pre-Covid vacation and leisure habits. An extra-long weekend in the middle of the month – around the Juneteenth holiday – seems to have led to more spending on services.

In real spending, there was only a modest movement in June, due to high inflation. If there is no higher jump in the inflation-adjusted reading, it means that the tendency to spend on savings has decreased, and there has been no change to better-paid jobs. As a matter of fact, the savings rate has decreased from 5.5% to 5.1%. If wages can sustain the upward momentum, consumers who find ways to cope with inflation can still create enough momentum for the economy to grow for the rest of the year.

The employment cost index (ECI), a measure of labor costs preferred by the Fed, made smaller progress at 1.3% in 2Q22. ECI, which is expected to increase by 1.2% in the second quarter, was announced as 1.3%. This is an early signal that wage growth is moderate. Unlike the average hourly earnings measure, the ECI checks for changes in the business mix in the industry. During the pandemic, this made the latter less reliable as an indicator of wage costs. Labor costs, which delivered a surprisingly strong first quarter result, complicated the picture. Labor costs because they can include paid leave, overtime pay, insurance or legally required benefits. Accelerating wages and salaries will be a clearer indication of the trend.

If we look at the Fed’s point of view; The market is calculating that interest rates will be cut next year. It is not possible to act only by looking at the weakening in economic growth projections, as the CPI, which is likely to be sticky, still makes the Fed’s hand difficult. For the Fed to switch to interest rate cuts, policy tightening for the medium term must be successful in reducing inflation. The short and medium term perspective is variable.

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