The Consumer Springs To Life And So Does Inflation

Scott Anderson
Chief Economist
Bank of the West

Real consumer spending and PCE inflation sprung back to life in April, muddying the waters for a June Fed rate hike pause, and continuing a string of stronger than expected economic data coming out of the United States.

U.S. Economic Surprises Turn Decidedly Positive
Real personal spending surged 0.5% or 5.8% annualized in April, following slightly negative growth in March. Real consumer spending on goods led the way rising 0.8% as real motor vehicles and parts spending jumped 2.3% in April. This was stronger than we forecast and boosts our estimate of Q2 real consumer spending growth to 1.0%

Motor Vehicles Drive Strong Gains in Personal Spending
The University of Michigan’s Consumer Sentiment Index for May was also revised sharply higher to 59.2 from an advance reading of 57.7. Both the current conditions and future expectations components of index saw sizable upward revisions, suggesting the April consumer spending trend may have some staying power over the rest of the second quarter.

Durable goods orders also surprised on the high side for April, increasing 1.1% following an upwardly revised 3.3% increase in March. We had been expecting a decline in durable goods orders last month following the strong March increase. The primary driver of the gain in new durable goods orders last month was defense aircraft orders that jumped 32.7%, pushing total defense capital goods orders up a whopping 36.1% from March’s level. Machinery orders and computer related product orders were also strong in April, rising 1.0% and 1.8% respectively. The rest of the durable goods orders report was relatively weak as expected. Computers and electronics orders plunged 1.4%. Electrical appliance orders fell 1.0%, and communications equipment and primary metals orders dropped 0.5%, respectively, while motor vehicle orders slipped 0.3%.

Durable Goods Orders Suprise To The Upside
Unfortunately with stronger consumer spending in April came a sharp rebound in PCE and Core PCE inflation. Both measures increased 0.4% or 4.8% annualized last month exceeding consensus forecasts and well outside the bounds the Fed would need to see to become more comfortable with the inflation trajectory. This is especially true if we get a solid May payroll report next Friday as we expect, currently forecasting an increase of 185k jobs.

Another rate hike from the Federal Reserve is back on the table for June, in fact it could soon become our baseline forecast, given the strength and resilience we continue to see from consumer spending and inflation, and assuming we can get past this debt ceiling X-date without a default.

At the time of this writing a debt ceiling agreement has not yet been announced, though bi-partisan negotiations appear to be progressing well and reports have surfaced in many news outlets that negotiators are closing in on an agreement for a two year debt ceiling raise that would include a two year discretionary spending freeze that could go to a vote in the House as soon as next Tuesday. This increases the chances a debt-ceiling raise agreement could clear the Senate and get to the president’s desk before the end of next week – likely arriving just in the nick of time to avoid a default on the nation’s debt. Estimates from the Treasury Department and others remain quite firm that the Federal government could run out of money to pay all its bills sometime between June 1st and June 9th.

Even if a debt-ceiling agreement passes in time to avoid a default, the U.S. economy isn’t completely out of the woods. We can expect real Federal discretionary spending cuts will occur over the next two years that could put a sizable dent in the U.S. GDP growth for 2024 and 2025 - in some quarters likely subtracting around a half a percentage point or more off of U.S. GDP. We are awaiting more information about the details of any agreement before we factor any of this into our baseline forecasts, but downside risks for growth in 2024 and 2025 are clearly rising, even as the near-term economic outlook has improved.

There is still a small risk that when the Congressional leadership brings the compromise debt ceiling agreement to their chambers for a vote the extremes of both parties decide to balk. Even one failed vote on the House floor could lead to a TARP like moment for the financial markets. In September 2008, the $700B Troubled Asset Relief Program (TARP) came up for a vote in the House and ended up 13 votes short of passage. The Dow Jones Industrial Average closed 778 points or 7% lower that day as a result. Never a dull moment in a democracy.

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


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