Personal spending declined on an inflation-adjusted basis in May as spikes in gasoline and food prices depressed consumer sentiment and dampened spending on other discretionary items.
If the trend continues, we should expect spending volume in June to decline further, adding more downside risks to our 2.5% growth forecast for gross domestic product in the second quarter.
Total personal spending fell by 0.4% from a month earlier after adjusting for inflation. The decline offset gains in April, which received a sharp downward revision to 0.3% in the same report from the Bureau of Economic Analysis released on Thursday.
Rising energy and food prices in May pushed the Federal Reserve’s key inflation gauge—the personal consumption expenditures price index—up by 0.6% from a month earlier and by 6.3% on a year-ago basis.
But unlike data on the year-over-year consumer price index that reached a new peak in May, the top-line PCE price index remained below its March peak as consumers shifted away from spending on fast-rising items like food and energy.
The data came out before next month’s Fed meeting, raising the possibility of another 75 basis-point rate hike from the central bank as inflation remained elevated for both the headline and core numbers. Core PCE rose by 0.3% in May and by 4.7% from a year earlier.
To be clear, the problems with energy and food prices have mostly been supply-side problems, which the Fed won’t be able to address using monetary policies.
If the Fed wants to target overall inflation, it will have to slow down demand substantially while hoping to avoid a recession. That soft-landing situation has become more unlikely in recent months as inflation proves to be much stickier than expected.
Income rose by a steady 0.5% in May, however, not enough to offset rising prices, which will disproportionally affect low and middle-income households whose share of spending on gasoline and food are the highest.
These households, at the same time, are dipping into their savings to maintain their lifestyle; the savings rate in May—at 5.4%—remained significantly lower than the pre-pandemic average of 7.4%.
Given the current level of historically low consumer sentiment, the more than $2 trillion of excess savings—which is mostly held by households in the top 20% of income earners—will continue to stay on the sideline.
If there is one silver lining from the spending report, it was the continuing shift from spending on goods to services, which has a significant implication on inflation. Much of the surge in inflation has come from goods.
Although spending on services has picked up, it remained steady at 0.3% month over month while goods spending dropped by a sharp 1.6% month over month. The big decline was driven by automobile spending, which is often one of the most sensitive components to rate hikes.