Turn-of-the-year issues were on display in the January personal consumption expenditures price index data that showed inflation rising at 2.5%, well above the central bank’s 2% target. Friday’s report will keep the Federal Reserve on the sideline with any rate cuts until the second half of the year.
Strong income gains driven by government transfer payments and rising monthly inflation are not likely to provide comfort to policymakers and investors who have watched inflation reaccelerate. Service costs, for example, increased by 3.4% from one year ago in January.
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While year-ago metrics of inflation eased, the increase in turn-of-the-year pricing should not be discounted.
In addition, the recent increase in short-term inflation expectations complicates any sustained move higher in prices given that the three-month average in the PCE index stands at 2.6% while the six-month pace is 2%. That difference captures the recent acceleration in pricing inside the PCE index, which is the Fed’s preferred gauge of inflation.
The data
The turn-of-the-year increases in Social Security payments of 2.8%, transfer payments of 1.8% and dividend payments of 1.7% were the primary catalysts behind the strong 0.9% increase in household income. Those increases helped boost the savings rate from 3.5% to 4.6%.
Compensation, wages and salaries increased by 0.4% while disposable income jumped by 0.9%. Personal income excluding government transfers increased by 0.3% once adjusted for inflation, and real spending increased by 3.8% on a three-month average annualized pace.
The traditional holiday hangover in household spending was evident in the 0.2% decline in monthly consumption.
Friday’s report reflected the traditional turn-of-the-year noise in spending, and we expect consumption to continue at or near a 3% path in the near term.
The inflation data reflected the recent increase in pricing even as year-ago metrics continued to slow.
Core inflation, which excludes the more volatile food and energy components, advanced by 0.3% and was up by 2.5% on a three-month annualized pace.
Food prices increased by 0.3% and energy costs advanced by 1.3%.
Goods prices increased by 0.6%, durables dropped by 1.2%, and non-durable prices increased by 1.6%, all from one year ago.
The takeaway
Underlying inflation appears to have flattened out near 2.5% on an annual basis with service sector costs rising at a 3.4% rate. But with the recent uptick in inflation, the Federal Reserve will not be looking to reduce its policy rate anytime soon.
Aggregate demand, supported by underlying income and labor dynamics, points to sustained spending, which does not provide much confidence that the Fed’s preferred inflation metric will move back to the central bank’s 2% target anytime soon.
