Personal spending rebounded in January even as inflation rose at the highest rate in decades. Consumers looked past the omicron surge to spend more for the first time in three months on an inflation-adjusted basis.
Spending rose 2.1% on the month, and 1.5% after adjusted for price increases while the personal consumption expenditures index came in at 0.6% month over month, the Bureau of Economic Analysis reported on Friday.
The resilience of American consumers in the face of the coronavirus and multidecade high inflation is evidence of how strong the current economic foundation is, providing the market a lot more room to absorb the impact of Russia’s invasion of Ukraine.
The invasion will be felt by American consumers first at the gas pumps as the U.S. benchmark for oil nears $100 a barrel, while the global Brent crude benchmark has already reached that price.
The energy shock will send inflation higher, but the pass-through effect from energy inflation onto core goods and services will not be as pronounced as it was in the past with production much less dependent on oil prices.
On a year-over-year basis, the overall personal consumption expenditures index—the Federal Reserve’s key gauge for inflation—reached 6.1% while the core PCE—which includes food and energy—advanced to 5.2%.
We expect the Fed will look through such volatility, given the current economic and geopolitical situation, while remaining ready to act swiftly when needed. An overreaction toward inflation pressure solely based on energy prices is the last thing that the U.S. needs as the lesson from the 2004-2006 period, with 17 rate hikes, still resonates.
Instead, there is a need for effective fiscal policies, which can target the most vulnerable parts of the population. We believe it makes sense to revive the enhanced child tax credit that has been effective in mitigating the additional stress put on families.
The program’s payments ended in December, and personal income stayed flat on the month. Wage income gains did not help to offset the drop in government transfers as consumers continue to spend down their extra income and the $2.5 trillion of cumulative savings. The savings rate in January was 6.4%, down from 7.9% in the prior month.
Such a significant amount of cumulative savings is another reason why a blanket policy will not be as effective as policies like the enhanced child tax credit that targets consumers with high marginal propensity to spend.
The takeaway
In the coming months, we expect the government will take center stage in driving the economy with more policies to mitigate inflation while keeping growth intact. The Fed, by contrast, will have to calm the storm with clear forward guidance as it looks to create a soft landing for the economy.
