American consumers pulled back in April as a sign of elevated interest rates weighing further on overall demand as fiscal spending from the pandemic wanes.
The material slowdown of the labor market in April was also a key factor with income growth essentially unchanged on an inflation-adjusted basis.
It was not a good start for the second quarter when growth had been expected to rebound from the disappointing 1.3% increase in the first quarter.
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But weakened economic conditions should work in the Federal Reserve’s favor regarding inflation. The personal consumption expenditures index, the Fed’s key gauge of inflation, came within expectations.
The so-called super-core metric, which includes services less energy, food and shelter, came in much lower than the prior month at 0.27%.
While American household balance sheets remain solid, the margin for discretionary spending has been much thinner now that excess savings have likely been exhausted as pent-up demand from the pandemic recedes.
Spending slowed the most for non-essential items like recreational vehicles, transportation services and recreational services.
But we don’t think that is a concern, yet. More likely than not, the economy is cooling down to a soft landing, a reason for the Fed to rethink its hawkish stance when it comes to keeping interest rates at a multidecade high.
The data should move the odds of rate cuts this year higher but won’t substantially alter our call for two cuts this year, yet. But if we get more data like Friday’s report in the coming months as disinflation continues, we think the Fed should act sooner rather than later so that it is not behind the curve again.
Inside the reports
Personal spending rose by 0.2% in April while income rose by 0.3%. Both were much slower than the previous month. With PCE inflation coming in at 0.3% on the month, after adjusting for inflation, real spending dropped by 0.1% while income was unchanged.
With a negative reading on real spending, the personal consumption component of gross domestic product in the second quarter should take a hit.
It is not a concern yet because spending posted an even bigger drop in the first month of the first quarter, falling by 0.3%. But without both fiscal and monetary support, while the labor market is much cooler this time around, we should not expect a surge in spending anytime soon.
Disposable income after adjusting for inflation dropped by 0.1% for the second time in three months.
As a result, consumers pulled back on discretionary items first. Recreational goods and services dropped by 1.3% and 0.3% on the month on an inflation-adjusted basis, respectively. Transportation services dropped by 0.7%.
The top-line PCE inflation was 0.3% in April, while the core reading inched down to 0.2%. On an annual basis, the readings were 2.7% and 2.8%, respectively.
The drop in core inflation was in line with our expectations based on the consumer price index data released this month. Airfares led the decline, falling by 3.2% on the month.
Housing inflation, one of the stickiest and largest components in calculating inflation, did not show any improvement in April, rising by 0.4% month-over-month.
But we believe that housing disinflation will show up around the end of the summer when new leases are signed and the impact of a real-time drop in housing prices finally catches up.
The savings rate stayed at 3.6%, the lowest rate since December 2022. As consumers continue to save less, we think that most of the pandemic excess savings have been depleted, especially for the lower-income earners, who are more susceptible to inflation and economic slowdown.
