Consumption Expenditures Report a Decrease, Indicating Negative Economic Trends
Rewritten Article:
Friday saw the release of the Personal Income and Outlay data, the Fed's favorite measure of consumer spending and inflation. The news isn't all rosy, though. While there are positives, there are also worrying trends that might prompt the central bank to reconsider their interest rates cut plans. If these trends continue, they could lead to a recession.
Why the Fed pays attention to consumer spending
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The Federal Reserve keeps a close eye on consumer spending, as it directly and indirectly impacts their dual mandate of maintaining stable prices and promoting full employment. Approximately 70% of Gross Domestic Product (GDP) is made up of consumer spending. When this increases, so does the economy. Conversely, if consumers hoard their money, the economy slows down.
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When consumer spending picks up, companies see more business and eventually need more labor. However, if spending dips, companies might delay hiring, and in a worse scenario, might even lay off employees. The Fed needs to balance both concerns, and consumer spending patterns are a crucial gauge. They often remind us that a single month's data may just be an anomaly. However, if it's the start of a trend, it should not be ignored.
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Why PCE is essential
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.”
PCE data is divided into two parts: disposable personal income (DPI) and personal consumption expenditures (PCE). While DPI shows how much money is allocated for personal use, PCE illustrates price changes or inflation. Usually, businesses and experts pay attention to Consumer Price Index (CPI). However, the Fed prefers PCE because it better reflects current consumer spending patterns and adapts more quickly to changes in spending behaviors.
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.
The latest PCE data
The Core PCE index, similar to CPI headline inflation, rose by 0.3% in a month and 2.6% year-on-year. This was lower than the December figure of 2.9%, but in line with expectations. However, the DPI was up by 0.9%, or $194.3 billion, but personal spending was down by 0.2% compared to December, which had projected an increase of 0.1%. In addition, real spending, which is adjusted for inflation, declined by 0.5%, reversing the growth seen in December.
The decline in consumer spending was broad-based, including real services spending which only increased by 0.1%. Chris Zaccarelli, Chief Investment Officer for Northlight Asset Management, called the report a "double-edged sword." He also noted that the savings rate rose to 4.6%, the highest since mid-2024, suggesting that consumers are being more cautious with their spending due to economic concerns.
It's too early to call this a trend, but it's worth keeping a close eye on. Factors such as economic uncertainty, financial stability, inflation concerns, value-driven options, seasonal and environmental factors, and credit conditions may contribute to this trend. If consumer spending continues to decrease, it could indicate broader economic issues that should be addressed promptly.
The decline in personal consumption expenditures, a key component of GDP, could potentially signal a shift in consumer behavior, which the Federal Reserve closely monitors due to its impact on their mandate. If the decrease in expenditures persists, it might necessitate a reevaluation of the Fed's interest rate cut plans.
The Fed's preference for the PCE index over the Consumer Price Index lies in its ability to reflect current consumer spending patterns more accurately and adapt more swiftly to changes in spending behaviors. This data can provide valuable insights for policymakers as they balance the need for economic growth and the potential impact of consumer spending trends.
Should the decrease in consumer spending continue to be a trend, it could have significant implications for businesses, potentially leading to delayed hiring or even job losses if companies are not able to meet demand. This amplifying effect on the economy is another reason why the Fed keeps a close eye on consumer spending trends.