The financial condition of American households is improving as the economy moves toward a full reopening and job opportunities expand.
Although personal income declined by 2% in May and personal spending was flat, according to government data released Friday, one has to look beyond the noise associated with the significant fiscal stimulus to understand this improvement.
In fact, beneath the headline numbers, the data on spending and income is quite strong and implies that investors, firm owners and policymakers should get ready for a strong economic expansion this summer.
Several dynamics at play show a strengthening economy:
First, remember that personal income was bolstered by 20.9% in March. A big reason was the fiscal aid of the American Rescue Plan, which arrived in the checking and savings accounts of American households and helped boost incomes. Once one adjusts for the significant impact of that aid, personal income excluding government transfers is up 0.56% over the past three months, which is undeniably strong and indicates that the financial condition of American households is improving.
Second, personal spending was flat, but there is more to the story. On an inflation-adjusted basis, personal spending declined 0.4%. But once one smooths out the noise from month to month that one would expect following such a large infusion of fiscal aid, personal spending is up 26.6% on a three-month average annualized pace, following a 19.9% increase in April and a 15.5% advance in March. This data implies that one needs to take a broader view when looking at the top-line data.
Third, the personal savings rate remains elevated. Though it eased to 12.4% from 14.5%, the personal savings rate will continue to be a source of household spending this year and next. The American household remains well positioned to continue spending as spring turns to summer and the long-awaited pivot to spending on services happens.
Last, but not least, prices remain stable. The policy-sensitive core personal consumption expenditure deflator—a key measure of prices—increased in May by 0.5% on the month and 3.4% on a year-ago basis, which is unchanged from April. Given that the latter is one of the policy variables used by the Federal Reserve, the arrival of the monthly top-line increase at 0.4% and core at 0.5%, slightly below expectations, will continue to stoke debate over whether the recent increase in inflation is sticky or transitory.
Our sense is that we will see price increases peak in the early fall and then begin to fade. One should anticipate further jawboning out of the Fed, known as open-mouth operations, around rising prices. Expect Fed officials to continue to sound slightly hawkish even as no change in policy will happen until later this year or early next year.
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