October’s personal income and spending data released by the government on Wednesday gave more reasons to end the short Thanksgiving week on a good note.
Personal income rose by 0.5% on the month, beating expectations of a 0.2% increase, while spending rose by a sharp 1.3% in October on a dollar basis. After adjusting for price changes, real spending remained strong at 0.7%.
All indicators on spending and income show strong improvements compared to September as the economy came back from the delta variant’s surge in late August and early September.
Spending rose in both goods and services categories. Within goods, the increase in spending on durables was led by automobiles, up by 5.0% on the month, while unsurprisingly, spending on gasoline and energy drove nondurable goods spending in October.
As the delta variant eased, services spending on transportation and recreation posted the largest increases on the month, up by 1.4% and 1.3%, respectively.
The gains in October’s personal spending performance were not as big of a surprise when looking at recent data on retail sales, which were up by 1.7% in October on nominal terms and by about 0.8% on real terms, adjusted for inflation.
On top of that, many retailers came out with deals in October to attract more shoppers this year than normal, another reason for the increase in spending.
In the personal income data, gains in compensation, wage and salary led the increase, rising by 0.8% on the month. Disposable income posted a more modest gain of 0.3%, still a significant improvement from the 1.3% decline in September.
On the other hand, the savings rate dropped to 7.3%, the lowest since December 2019, continuing to show signs of the switch from historic cautionary saving behavior during most of the pandemic to rising spending as the pandemic eased.
The Fed’s inflation gauge
The personal consumption expenditures deflator—the Fed’s favorite inflation indicator—rose by 0.6% on the month and by 5.0% on the year in October.
The monthly increase in PCE matched the increases in April and March, while the yearly increase marked the highest level in three decades. And it was not much of a surprise following October’s surge in inflation.
The PCE deflator was also followed by the core index, which excludes food and energy prices, rising by 0.4% month over month and by 4.1% year over year.
The record-high PCE deflator numbers will add to the pressure on the Fed as the market is pricing in a faster pace of tapering and an earlier start to rate hikes next year.
One data point that is surely not in favor of dovish members of the Fed also came out Wednesday: The University of Michigan’s long-term inflation expectation for the next five to 10 years rose to 3.0% in the final report compared to 2.9% in the preliminary report.
We expect an acceleration of tapering operations at the December meeting, which will open a door to an earlier-than-anticipated rate hike around December 2022. There is also the possibility of a rate hike as early as September, yet rate hikes during an election year are often hard to predict.
Overall, Wednesday’s data reaffirmed our forecast of a better-than-expected holiday season that will feed into growth for the last quarter of the year, which will be around 5.6%, according to our forecast.
On the flipside, strong spending might continue to add pressure on prices in the last two months of the year. But recent data has been showing an improvement in the supply chain snarl that can play a role in easing such pressures.