Lots of income but not much spending in January – with inflation as expected.
Personal income jumped by 0.9 percent in January (about double expectations) while personal consumption expenditures (PCE) fell by 0.2 percent (markets were looking for a small increase). The weak retail sales report certainly suggested that the broader PCE measure would slow, but not by this much (with real PCE down at an annualized pace of 0.5 percent). Should we be concerned that these weaker spending numbers for January presage a significant slowdown in the economy (after all, the spread between the 3-month and 10-year Treasury note yields just inverted again in the past couple of days)? At this point it’s much too soon to say that a downturn is imminent. The weak January figures came after strong fourth quarter spending (especially for December) and they may also have been impacted by worse-then-usual winter weather. Economic growth has remained above trend over the past year, so the optimistic view could be that taken together, the spending data over the past 3-4 months suggests that the economy is slowing closer to trend rather than stalling (or worse).
But what about inflation? After all, the Fed has often stated that its preferred inflation measures are the PCE and core PCE price indices. Both the overall and core (excluding the volatile food and energy components) rose by 0.3 percent, equal to market expectations. While expected, this monthly growth still translates into a 3.7 percent annualized pace – well above the Fed’s 2.0 percent long-term goal. But any one-month’s data can be volatile and analysts (including those at the Fed) prefer to look at the trend. Despite these higher one-month inflation gains, the 12-month trend rates of both measures fell – with overall PCE inflation edging down to 2.5 percent and the core dropping to 2.6 percent (the slowest gain since last June). Still above the Fed’s goal but moving again in the right direction.
Some analysts have raised the issue of Fed tightening this year, given increases in inflation over the last 4-5 months of 2024 and continued above-trend economic growth. Today’s figures suggest that the Fed will continue to be cautious about any near-term change in monetary policy until the trend in growth and inflation becomes clearer. If the PCE figures in coming months suggest further weakness, we could see Fed easing by mid-year (especially if the PCE inflation figures continue to edge lower). But if the January PCE figures are a one-off and consumers continue to spend (and if the trend PCE inflation figures level off or move higher), it is possible that the Fed could tighten policy a bit this year. Most likely is that the Fed will keep policy unchanged for a while, with economic growth slowing modestly (but still probably remaining above trend) and inflation not moving higher (and hopefully moving a bit lower).
David W. Berson, Ph.D., CBE
Chief US Economist
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