Consumers spending with more discretion as inflation reassures
- Consumers remain willing to spend, but not on anything, nor at any price. Real consumer spending rose a moderate 0.5% month over month (m/m) in March, driven by a strong appetite for goods. With real disposable income only rising 0.2% m/m, households dipped into their savings to finance their outlays — the savings rate fell 0.4 percentage point (ppt) to a 17-month low of 3.2%.
- As we enter the spring, real consumer spending is currently trending at a healthy clip of 3.1% year over year (y/y), but real disposable income growth has slowed to a slower pace of 1.4% y/y — the slowest pace since January 2023. While the labor market remains robust, there is increased evidence of cooler labor demand, which along with softer wage growth, will constrain income momentum in the coming months. We anticipate consumer spending growth will average 2.3% in 2024.
- The headline and core personal consumption expenditures (PCE) deflators rose a moderate 0.3% m/m — less than feared after the GDP print. As a result, headline PCE inflation rose 0.2ppt to 2.7% y/y while core inflation held steady at 2.8% y/y — its lowest since March 2021.
- While short-term disinflation dynamics stalled in Q1, much of this is due to noisy data in January and February. Looking ahead, slower income growth will lead to cooler consumer demand while higher price sensitivity, reduced markups, declining rent inflation and moderating wage growth form the ideal combination for further disinflationary momentum. We see headline and core PCE inflation moving toward a 2.5% y/y “inflation plateau” over the summer and fall.
- Importantly, this plateau won’t be so far above 2% that it would warrant excessively tight monetary policy. First principles continue to favor disinflation and policymakers’ laser-focused battle to rapidly bring inflation to the 2% target could do more harm than good for the US economy.
- While the contrarian view of Fed rate hikes has become trendy, we continue to stress that the bar for rate hikes is elevated. Almost all policymakers believe that the policy rate is likely at its peak for this tightening cycle and that it will be appropriate to ease policy at some point this year. We foresee two rate cuts this year in July and November.
In the details
Real personal outlays climbed 0.5% m/m in March, following a similar gain in February:
- Real durable goods outlays led the way, up 0.9% on broad-based gains. Outlays on motor vehicles rose 0.8% after a 2.8% rebound in February in the wake of the 5.3% plunge in January. Spending on furnishings and household equipment also rose a healthy 0.8% while spending on recreational goods increased 1.1%.
- Real spending on nondurable goods advanced 1.3% — the strongest gain since June 2021 — as consumers splurged on groceries, up 1.1%, and gas, up 4.4%, while cutting back on clothing (-0.6%).
- Services outlays posted a modest 0.2% advance in March, following a 0.6% gain in February. Spending trends were heterogenous with consumers spending more on recreation services (+1.1%), health care (+0.6%) and financial services (+0.4%), but spending more modestly at restaurants and bars (+0.3%) and on utilities (flat). Spending on transportation services contracted 0.7% on a pullback in air travel.
Personal income rose a moderate 0.5% in March driven largely by robust compensation trends, but disposable income adjusted for inflation only rose a modest 0.2%:
- The 0.7% increase in wages and salaries was the second largest gain in a year, a sign that resilient labor market conditions continue to underpin wage momentum.
- Gains across other income categories were generally positive but modest.
On the inflation front, the headline and core PCE deflators advanced 0.32% on the month — less than feared after the first quarter data in the GDP print. While the short-term dynamics indicate less progress toward the Fed’s 2% target, the underlying momentum across categories doesn’t appear concerning, and there is no evidence of a reacceleration in inflation:
- Durable goods prices rose a tick on the month as lower car prices were offset by higher recreational goods and vehicles prices.
- Nondurable goods prices rose 0.2% led by higher gas and clothing prices.
- Services prices were a little on the hot side, rising 0.4%, led by a pop in transportation services prices (+1.6%). More broadly, housing prices and financial services and insurance prices rose 0.5%, restaurant prices rose a modest 0.2%, and health care prices rose a tick. Recreation service prices fell 0.2%.
