A mix of declining inflation-adjusted income growth, a reliance upon savings and credit to fund spending and a 3.7% increase on a three-month annualized pace in core inflation does not paint a flattering portrait of an economy in February, on the edge of war.
While nominal spending advanced, inflation-adjusted income and inflation dynamics in February deteriorated while the economy headed towards an historic oil shock.
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We think that the investment community may be tempted to dismiss the personal consumption expenditures index data released on Thursday as stale, but it does so at its own risk.
We are certain that American central bankers will not do so, given the 3.7% three-month average annualized pace of core inflation and the ugly inflation-adjusted income and savings dynamics inside the February report.
This deterioration occurred as personal income and disposable income fell by 0.1% amid a 0.4% increase in core inflation.
Once one adjusts for inflation, income excluding government transfers declined by 0.4% and disposable income dropped by 0.5%, all of which is consistent with the gloom that has settled in over the public on affordability.
At the same time, personal spending increased by 0.5% in February, which implies a decline in savings, which dropped to 4% from 4.5% as consumers relied on credit to cover spending.
The top-line increase of 0.1% on the month and 2.8% annually took place before the war. Expect the March data to show an increase in the core metric, which is the best long-run predictor of overall inflation.
That March data will be far more problematic for central bankers who are now six years into a journey well above the Federal Reserve’s 2% inflation target, no matter the outcome of the ceasefire.
The data
The savings rate dropped to 4% from 4.5%, which explains the increase in spending given the relatively weak income dynamics across the report. Compensation increased by 0.2% in March, as did wages and salaries.
Core inflation is running at a 3.7% three-month annualized pace, which should provide no comfort to any American central banker who is now pondering if and how quickly top-line inflation driven by an oil shock may bleed into core inflation.
On a year-ago basis, goods prices increased by 1.8%, non-durables by 1.3% and food prices by 2.3% while energy prices fell by 0.1%.
The takeaway
While the report will mostly be dismissed by the investment community as stale, the Federal Reserve will pay close attention to the data.
Given the oil shock now cascading through the U.S. economy, the February income dynamics once adjusted for inflation are not what one would want to see in an economy on the edge of war.
The dynamics create the conditions under which sustained increases in energy prices could spread into the service sector.
Perhaps more important, the sharp decline in the savings rate to cover spending while core inflation increased by 3.7% on a three-month average annualized pace strongly underscores the growing economic discontent of the American public.
