Personal income and spending January 2024

Cost fatigue limits consumer enthusiasm

• Consumers took a breather in January following an expensive holiday season. Still, while households will exercise more scrutiny in the face of elevated prices, there is no indication of an impending retrenchment in spending. 
  
  
• As long as the labor market remains robust, income growth should remain solid and offset the drag from higher prices, elevated debt servicing burdens and reduced savings. Consumer spending should grow around 2.0% in 2024.
  
  
• As indicated by the Consumer Price Index (CPI) and Price Index (PPI) data, inflation stickiness was apparent in the personal consumption expenditures (PCE) deflators in January. But the underlying disinflationary dynamics remain firmly in place including increased price sensitivity, reduced margins, wage growth compression and easing shelter cost inflation. PCE inflation will likely end the year around 2.0%-2.2% year over year (y/y).
  
  
• Given the noisiness of the January data, we maintain our view that the first Fed rate cut will come in May but acknowledge the risk that the hotter-than-expected monthly inflation prints could provide hawkish Fed officials with the necessary justification to delay the onset of the easing cycle until mid-year.
  
  
• With most inflation gauges around 2.5%, you would expect Fed officials to start considering easing monetary policy. Yet, the painful burn of having tightened monetary policy too late in 2022 lingers, favoring more restrictive policy than optimal.

Consumers took a breather. Real personal outlays fell 0.1% month-over-month (m/m) in January, the first decline since August 2023. 

• Durable goods outlays fell sharply, down 2.5%, on a broad-based cutback in spending that was likely affected by poor weather. Outlays on motor vehicles fell 3.7%, spending on recreational vehicle decreased 2.0% and spending on furnishings and household equipment declined 1.4%. 
  
  
• Spending on nondurable goods fell 0.5% as consumers spent less on gas (-1.4%) and groceries (-0.2%) and a little more on clothing (+0.7%).  
  
  
• Services outlays posted a third consecutive robust 0.4% gain, but the most significant gains appear to have been on necessities rather than desires. Households spent more on financial services and insurance (+0.7%), housing and utilities (+0.6%), health care (+0.3%), transportation (+0.3%) and restaurants and bars (+0.2%), but a little less on recreation services (-0.3%).

A large nominal income surge entirely offset by taxes and inflation. Personal income rose a strong 1.0% in January, driven in part by a decent 0.4% bump in wages and salaries, but largely by strong dividend income reflective of the solid stock market performance and the annual bump in Social Security, Medicaid and other government transfers. Higher taxes took a bite out of this income, so that disposable income rose a more modest 0.3%. After adjusting for inflation, real disposable income was flat on the month. The much weaker January gain relative to last year translated into a notable slowdown in the annual pace of real disposable income to 2.1% y/y – its slowest pace since December 2022.

Not saving much. With income outpacing spending in January, the personal savings rate rose a tick to 3.8%. Still, this is a gauge to monitor closely as consumers stretching their finances for the holidays is one thing, but an ongoing savings dip is another.

Don’t fret about it. The PCE deflator rose 0.3% m/m in January while the core PCE deflator rose 0.4% m/m. This pushed headline PCE inflation 0.2 percentage points (ppt) lower to 2.4% y/y – its lowest since February 2021 – while core inflation eased 0.1ppt to 2.8% in January — its slowest pace since March 2021. As a result of the strong monthly gain, the three-month annualized, and six-month annualized headline PCE inflation readings rose to 1.8% and 2.5%, respectively – after hitting their lowest post-pandemic marks in December. The three-month annualized and six-month annualized core inflation readings rose to 2.6% and 2.5%, respectively. 

Taking a step back, it’s important to stress that these inflation readings are within striking distance of the Fed’s 2% target. It would seem optimal for the Fed to consider easing monetary policy gradually.

No justification for a difficult last mile. As we look ahead, there is no doubt that the disinflationary process will remain bumpy, and there will be monthly readings that surprise to the upside. Insurance cost inflation, rising home prices and geopolitical risks are certainly worth monitoring carefully. But slower consumer demand growth, increasing price sensitivity, declining rent inflation, narrower profit margins, moderating wage growth and tight monetary policy form the ideal combo for further disinflationary momentum in 2024.