American consumer spending barely kept up with price gains in June as the Federal Reserve’s key inflation gauge—the Personal Consumption Expenditure price index—reached a new multi-decade high, according to government data released Friday. Additionally, personal income declined for the first time since April as inflation took a bite out of pay growth.
While many believe inflation might have peaked as energy and commodity prices have come down significantly in July, the personal spending and income data from the Bureau of Economic Analysis reinforced fears of persistent wage inflation as the Employment Cost Index—a proxy for compensation growth—topped market estimates, remaining at a near-record high in the second quarter.
PCE price index and Employment Cost Index data is some of the most important information that the Fed monitors to base its policy decisions on. And as Fed Chair Jerome Powell reaffirmed Wednesday that the Fed will relax its forward guidance strategy and rely on new data to make its decisions meeting-by-meeting, Friday’s data on inflation and labor cost does not help much to alleviate inflation concerns.
Personal spending and income
June’s personal spending and income report was somewhat anti-climactic as the most important data point, which was on consumer spending, could be inferred from Thursday’s GDP report.
Spending rose 1.1% on the month, strong enough to surpass a new multi-decade-high monthly inflation growth rate of 1%. After adjusting for inflation, spending ticked up 0.1% in June. The shift from spending on goods to services slowed down in June as both categories grew 0.1% month-over-month on an inflation-adjusted basis.
Elevated inflation numbers, however, pushed monthly change in real income to negative territory for the first time since April, down 0.3%. It is important to note that steady real personal income and a strong labor market have been the main reasons why we are holding off any official recession call. Thus, such data on income will certainly raise the probability of recession.
As a result, consumers continued to reach into their savings to be able to keep their spending afloat. The household saving rate fell to 5.1% in June, its lowest point since 2009. That eroded the amount of excess savings that was accumulated since the start of the pandemic to $2.2 trillion from the peak of $2.4 trillion in December 2021 on an inflation-adjusted basis.
As the economy descends toward a recession, this amount of excess savings will be the lifeline for American consumers to keep up with inflation and potential job losses.
Labor costs
The Employment Cost Index rose 1.3% in the second quarter, slightly lower than the 1.4% record high in the first quarter. However, the subindex for private workers, which accounts for most of the labor force, increased 1.5%, adding more pressure on inflation concerns.
The main driver was private wages and salaries, which grew 1.6% in the second quarter, the highest since the third quarter of 2021. Private benefits grew slower at 1.3% after reaching a whopping 1.9% increase in the previous quarter.
The Fed watches this data very closely as a proxy for labor cost growth because it better adjusts for composition of workers and includes benefits that employers pay for. The data showed no sign of wage pressure coming down.
The takeaway
As the first-round effect of inflation on goods and services continues to play out, the second-round effect on wage pressure is showing more concerning signs. We believe any speculation on whether the Fed has reached its peak hawkishness in terms of monetary policy might be premature.
While more signs of a significant slowdown in economic activities appear, we expect the Fed to continue hiking rates until inflation is meaningfully under control.
