U.S. households moved to pull forward outlays on durable goods in February to avoid what will be a large increase in taxes on imported goods even as improvement on inflation continued to stall.
Core inflation—the type that will increase further on the back of rising tariffs—increased by 0.4% on the month and by 2.8% from one year ago, as measured by the personal consumption expenditures price index.
U.S. households in February increased their outlays on durables once adjusted for inflation by 1% on the month. Spending on nondurables increased by 0.5% and services declined by 0.1%, the Commerce Department reported Friday.
Given that the 0.8% increase in income was driven by a 2.2% increase in government transfer payments, spending will most likely slow in the coming months as trade taxes, set to take effect in April and May, dampen purchasing power.
That consumers chose to increase outlays on goods that are about to see price increases at the expense of the far more economically important service sector provides insight into the mindset of the consumer.
Inflation-adjusted income excluding government transfers increased by a modest 0.1%, which does not exactly suggest that the consumer is ready to spend through another round of price shocks.
My sense is that the Federal Reserve will look at this data and conclude that the current path of monetary policy needs to err on the side of the Fed’s price stability mandate and that any conversation around rate cuts needs to be pushed back to the second half of the year.
The data
On a nominal basis, income increased by 0.8%, compensation was up by 0.5%, wages and salaries by 0.4% and disposable income by 0.9%.
Spending was up by 0.4% on the month and climbed by 5.4% on a three-month average annualized basis while the savings rate increased to 4.6% from 4.3%.
Proprietors’ income with inventory valuation and capital consumption adjustments, which provides insight into the corporate earnings environment, was flat over the past two months and increased by 0.1% in March.
Read more of RSM’s insights on the economy and the middle market.
Once one adjusts for inflation, personal income excluding transfers increased by 0.1%, disposable income by 0.5% and personal spending by 2.1% on a three-month average annualized basis. Personal interest income advanced by 0.5% and personal dividend income climbed by 0.2%.
The top-line PCE price index advanced by 0.3% on the month and by 2.5% from a year ago while core inflation increased by 0.4% and by 2.8% on a year-ago basis.
A bit more troubling was that core services excluding housing, which the Fed watches closely when setting policy, increased by 4.1% on a three-month average basis, by 3.7% over the past six months and by 3.3% over the past year.
This increase will almost surely, in addition to the impact of the trade war, shape inflation expectations.
On a three-month annualized basis, top-line PCE inflation increased by 3.2% and by 2.2% on a six-month annualized pace. Inflation excluding food and energy advanced by 2.8% and by 2.6% over those same periods.
The price of food was flat on the month and energy advanced by 0.%. From one year ago, food costs were up by 1.5%.
Goods prices increased by 0.4%, durables dropped by 0.9%, nondurables increased by 1% and services rose by 3.5%, all from one year ago.
The takeaway
The primary takeaway from the February income, spending and inflation data is that households are preparing for what they believe will be another price shock caused by an increase in the costs of goods through a policy-induced trade shock.
We have made the case that if tariffs are a one-time event, that does not cause retaliation and is not followed by an increase in inflation expectations and, ultimately, a sustained increase in inflation.
Behavior by American households implies that consumers are preparing for the opposite. Pervasive retaliation by U.S. trade partners and are in the process of pushing up their own inflation expectations.
Because expected inflation determines actual inflation, it is rational that policymakers, the public, investors and firms prepare for a rise in costs that will spill over into services.
This scenario should for fiscal policymakers create the conditions to seek deals as soon as possible around mitigating the damage that is caused by an expanding trade war.
