A Strong Start To Consumer Spending In 2023

Scott Anderson
Chief Economist
Bank of the West

The January personal income and spending report came in even hotter than expected, underscoring the continued resilience of U.S. consumers, but was categorically negative for investors and the Fed in its battle to lower inflation. Real consumer spending jumped at sizzling 14.5% annualized rate in January with strong gains in motor vehicles and parts and recreation goods, food services, and accommodations spending. However, inflation continues to take a toll on the purchasing power of consumers. Real personal disposable income ex. transfer payments increased an anemic 0.1% in January or 1.1% annualized continuing a slowdown that started last August.

Real Personal Income Barely Beating Inflation
With that said, nominal disposable income jumped a whopping 2.0% in January as an 8.7% Social Security COLA increase came through for millions of Americans and likely was a big factor in the consumer spending windfall last month.

Real consumer spending rebounded a solid 1.1% in January after two consecutive monthly declines. The largest monthly advance since March 2021 was led by a 2.2% increase in spending on goods with spending on services rising a more modest 0.6%. The strong monthly upturn pushed the year-ago growth rate up to 2.4% – the fastest year-on-year pace since May 2022.

Spending Growth Accelerated Further In January
Unfortunately, inflation was as equally “hot” as spending last month. The PCE core deflator – which excludes food and energy and is closely monitored by the Fed – increased 0.6% in January or 7.1% annualized, accelerating from a 0.4% increase in December. Core PCE inflation from a year ago increased to 4.7% from 4.6% in December. This will surely garner the attention of the Fed and raises the risk of further rate hikes to sufficiently slow inflation.

The Consumer Spending And Inflation Outlook
Continued elevated inflation, additional Fed rate hikes, increasing long-term interest rates, tightening financial conditions and a faltering global economy are collectively expected to limit U.S. consumers’ ability to spend this year. Real consumer spending is forecast to drop at a 0.5% annualized rate in the second and third quarters of 2023, the first back-to-back quarterly declines since early 2020.

Danger - Consumer Slump Ahead!
On the brighter side, a prolonged spending strike by consumers and a mild U.S. recession is expected to bring somewhat better news on the inflation front by 2024. Core PCE inflation is forecast to continue decelerating through next year and close in on the Fed’s medium-term target of 2.0% in the second half of 2024. This should allow the Fed to cut interest rate cuts in 2024 to support the recovery.

PCE Core Deflator Growth Projected To Moderate
The Fed will eventually prevail in its quest to lower inflation, but not without some real economic and financial pain. While job gains have remained solid thus far despite higher interest rates, the economy is projected to shed net jobs in the second and third quarters of this year and push the jobless rate up to a peak of around 4.8% by the first quarter of 2024, up from a cycle low of 3.5% in the current quarter. The tradeoff of higher unemployment for lower inflation is one the Fed will be willing to accept to achieve its inflation mandate over the medium term.

To learn more, check out this week's U.S. Outlook Report.


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