Investors shouldn’t worry about stagnated consumer spending in May as incomes declined. New inflation numbers, however, give investors a bit more to chew on.
In a report Friday, the Bureau of Economic Analysis said spending was unchanged compared with April as personal income fell 2%. Economists saw the decline in income coming and expected a sharper 2.8% rate of decline. The spending drop was a surprise—economists predicted a 0.4% increase in outlays last month—but most say underlying consumer strength remains intact.
“Both capture the fading of the impact of the stimulus payments made under the March Covid bill,” says Pantheon Macroeconomics’
of the income and spending numbers. “We expect the underlying upward trends to re-emerge over the next couple months, when the reopening of the economy and the rebound in employment will become the dominant forces,” he says.
He added that even if June spending is flat after the decline in May, consumption will have risen a record 10.2% in the second quarter in part thanks to upward revisions to April figures. (Consumption is about two-thirds of gross domestic product.)
And as Jefferies economist
points out, incomes are still up 8.8% and spending is still up 5.3% from prepandemic levels. “Consumers are far from being tapped out,” she says, adding that “they are still sitting on $2.3 trillion in excess savings since the start of the pandemic.”
“In light of this, the May spending weakness looks like a pause, perhaps exacerbated by temporary capacity constraints in the service sector,” says Markowska.
Within the BEA’s income and spending report is the personal consumption expenditure index, the Federal Reserve’s preferred inflation metric. The good news: the PCE in May versus April rose at a slightly slower pace than economists projected. The not-so-good news: from a year earlier, the PCE is up 3.9%, marking the fastest clip since August 2008.
Backing out food and energy as the Fed does, the core PCE increased at a 3.1% pace, the hottest rate since April 1992 and well above the Fed’s longstanding 2% inflation target.
While many economists say some of the inflation pressure bubbling across the economy is likely transitory, owing to reopening bursts and supply shortages, signs that spending is shifting from goods to services means some price increases may be stickier.
“Look for goods inflation to abate and the upward pressure on service sector prices to pick up as bottlenecks are resolved and consumers pivot into spending on services over the summer months,” says Grant Thornton’s
For his part, Shepherdson says core PCE may have peaked in May. Still, it’s too soon to dismiss inflation as altogether temporary. “The key question for the Fed,” Shepherdson says, “is whether the spike in core inflation raises inflation expectations, and whether employees have the power to translate higher inflation expectations into faster wage growth. The jury is out, and a clear verdict is unlikely before late fall.”
To that point, compensation jumped 0.7% in May from April, to a record high. Translation: transfer payments fell 11.7% month-over-month as the stimulus check effect ended, says Cornerstone Macro’s
but earned income is rising fast. Lazar says compensation’s all-time high is important, as it is the single biggest driver of longer-term consumer spending.
As businesses ramp up hiring to meet booming demand, some are raising pay and offering bonuses. Wages are key to watch as the transitory-versus-persistent inflation debate unfolds.
Also worth considering Friday are the revisions to the University of Michigan’s June sentiment report. The headline confidence reading was revised higher, to 85.5 from a preliminary 86.4. While consumers expect a better economy in the months ahead, inflation concerns continue to weigh. Such concerns, says MFR’s Josh Shapiro, are holding the sentiment index more than 15 points below its immediate prepandemic level.
“Consumers continued to pay close attention to three critical factors: inflation, unemployment, and interest rates,” the University of Michigan’s report says. More than half of those surveyed expect the unemployment rate to fall in the year ahead–the largest proportion ever recorded in the survey’s history.
With expectations for stronger growth, however, come concerns about inflation and interest rates. Nearly three-quarters of all consumers expect rising interest rates in the year ahead, the highest since 2018 when the economy was near its last peak, says the report.
The expected year-ahead inflation rate was down in June from May’s high 4.6%, but the June rate was revised up to 4.2% from a preliminary 4%. Moreover, that’s still higher than any other time in the past decade.
“Look for goods inflation to abate and the upward pressure on service sector prices to pick up as bottlenecks are resolved and consumers pivot into spending on services over the summer months.”
Spontaneous references to high prices for homes, vehicles, and household durables rose to the worst level since the all-time record in November 1974. Such unfavorable perceptions of market prices reduced overall buying attitudes for vehicles and homes to their lowest point since 1982, the University of Michigan says. The declines were especially sharp among those with incomes in the top third, who account for more than half of the dollar volume of retail sales.
Along with wages, Fed officials are closely watching inflation expectations for signs of sticker pricing pressure. Markowska of Jefferies points out that inflation, transitory or not, eroded purchasing power in May (as shown by the 0.4% decline in personal spending in Friday’s report).
It’s too soon to worry about slowing growth vis-à-vis slower consumer spending, at least in terms of the current quarter. But diminishing purchasing power along with still-high inflation expectations are key for predicting growth beyond the second quarter—and for anticipating timing of any Fed policy action.
Write to Lisa Beilfuss at [email protected]