Key inflation, spending and income data released on Friday should make the Federal Reserve’s so-called dovish rate hike of 25 basis points in March a lot more reasonable by now. It also reaffirmed our call that the end of the hiking cycle is only a couple of months away.
While the data certainly showed all three indicators cooling in February, inflation remained higher than the target rate for the Fed to pull back on interest rate increases.
Prices overall, or the personal consumption expenditures index, grew by 0.3% on the month. For the core component, they rose by 0.3% while the the super core—which includes services but strips out food, energy and housing and is the Fed’s main focus—stayed at 0.3%, according to Commerce Department data released Friday.
On an annualized basis, the super core remained between the 4% and 5% range for most measures.
That was too high for the Fed’s comfort despite disinflationary signs from the headline year-over-year inflation for all components, which fell to 5.0% from 5.3%.
Friday’s strong inflation data had been anticipated. Job and consumer price data that came out early this month raised the chance of a 50-basis-point hike, but then multiple bank failures tamped down that expectation.
Since then, concerns over financial system stability have shaved off about 50 basis points from the Fed’s potential peak policy rate in our estimate. March’s rate hike attempted to strike a balance between acknowledging the risks from financial instability and inflation.
So far, the shock from multiple bank failures has calmed somewhat, reflected in both market sentiment and the Fed’s report of a “sound and resilient banking system.”
Personal spending growth slowed significantly in February, rising by 0.2%, while income growth fell to 0.3% from a month earlier. After adjusting for inflation, spending volume declined by 0.1%.
Still, the slowdown did not mean a major shift in American spending resilience. Much of the slowdown was because of a robust January, when spending increased by 2.0% in dollar terms and by 1.5% after adjusting for inflation.
Both numbers were revised upward. The one-time Social Security adjustment also contributed to a strong January for income growth, rising by 0.6%.
We estimate that excess savings at near $1 trillion by the end of February will remain a tailwind for spending at least for the first half of the year.
With the underlying economic conditions pointing toward solid growth and strong job gains, and inflation staying higher than the target rate, we won’t be surprised if the Fed adds one or two 25 basis-pont hikes in the summer and pause for the rest of the year.
Inside the data
Spending volume after adjusting for inflation was down for both services and goods in February, dropping by 0.1% on the month and disrupting the rotation from goods to services for the second month in a row.
The drop was driven by the declines in spending on autos, restaurants and apparels, which were down by 3.9%, 2.1% and 1%, respectively.
Spending on gasoline led the increase, rising by 3.1%, following by transportation services at 1.1%.
The savings rate inched up to 4.6% from 4.4% in the prior month, amounting to $915.8 billion in February.
Service inflation grew by 0.3%, while goods inflation grew by 0.2% in February.
Price pressures were most elevated in categories like recreation services (up by 0.9%) and food services and accommodation (up by 0.7%). Only autos registered a drop in prices with a 1.0% decline on the month.
