FILE – Customers wait in line for eggs at a Costco store in the Van Nuys section of Los Angeles on … [+]
The Personal Income and Outlay data — the Federal Reserve’s preferred measure of consumer spending and inflation — were released on Friday. There is some good news but also some that is disturbing. The central bank will take notice and probably reconsider how much more interest rates could be cut this year. They’ll have no choice, if this becomes a trend, it could set off a recession.
Why the Fed watches consumer spending.
The Fed pays close attention to consumer spending because, directly and indirectly, it touches on the organization’s dual mandate to maintain stable prices and maximum sustainable employment.
About 70% of gross domestic product, the common measure of the economy, is consumer spending. When spending grows, so does the economy. The economy slows when consumers keep their money in their pockets. When spending increases, companies see more business and eventually need more help. As spending trails off, companies eventually postpone hiring. If markets get worse, executives eventually lay off workers.
The central bank has to balance both concerns and the activities of consumers are a critical gauge, as are jobs and unemployment rates. Fed Chair Jerome Powell and other officials at the organization have been clear that a single month’s data can be an aberration. Then again, they can be the start of a trend.
Why PCE is so important.
When it comes to consumer spending and inflation, there are two measures the Fed and others can use. One is the Consumer Price Index (CPI) from the Bureau of Labor Statistics. It is the compilation of research into how much a standard set of products and services cost in different places of the p
There are two parts to the data. One is disposable personal income, called DPI, and personal consumption expenditures, or PCE. The latter shows how prices rise. In other words, it’s a measure of inflation, like the Consumer Price Index (CPI).
Many experts and businesses focus on CPI but the Fed prefers CPI: “While the two are similar, the PCE index is constructed in a way that accounts for how Americans are spending their money at a given time and more quickly adapts to changes in spending patterns.”
What the PCE data showed.
There was good news. The Core PCE index, similar to headline inflation with CPI, was up 0.3% month over month and up 2.6% year-over-year. That was down from 2.9% in December and was expected.
And some data complicated things. DPI was up 0.9%, increasing $194.3 billion. And yet, personal spending was down 0.2% from December when projections were an increase of 0.1%. December had been up 0.7% over November.
Sal Guatieri, senior economist at BMO Capital Markets Research in a note said real spending, which would be after inflation, was down 0.5%, reversing an increase in December. The pullback in buying was broadly based. “Even real services spending was on the light side, up just 0.1%,” he wrote.
Chris Zaccarelli, Chief Investment Officer for Northlight Asset Management, in an emailed note called the report the “ultimate double-edged sword.” He also pointed out that the savings rate rose to 4.6%, “the highest since mid-2024 as consumers tempered their views on the economy.”
Trying to understand the consumer spending drop.
A cold January and wildfires in Southern California might have been factors, as a desire to pay down credit card bills after holiday shopping.
Data from Moody’s Analytics the other day said almost half of consumer spending comes from the economic top 10% of households, which alone presents a risk. But if the rest of consumers also pull back purchasing, because they’re stretching themselves financially, there could still be an economic cooldown. It’s too soon to claim a trend, but not too soon to pay attention and be vigilant.