This past year was a remarkable one in the American economy as inflation eased, employment gains remained rock solid and household consumption advanced at a robust pace.
We are lifting our fourth-quarter GDP estimate to 2.8% with risk of a faster pace closer to 3%,
November’s personal income and spending report, released by the Commerce Department on Friday, showed a 0.4% monthly increase in nominal income and spending, while inflation-adjusted spending advanced by 0.3%.
These increases happened as growth in inflation, as measured in the personal consumption expenditures index, continued to ease.
The broad-based disinflation now moving through the economy should result in further relief in overall inflation. As rents ease toward a more tolerable 2% to 4% next year, it is likely that the Federal Reserve will firmly pivot toward stabilizing real rates, which will create the conditions for a sustained business expansion.
The PCE deflator declined by 0.1% on the month and was up by 2.6% on a year-ago basis. Core PCE, which excludes the more volatile categories of food and energy, increased by 0.1% on the month and by 3.2% from a year ago.
More important, the six-month annualized average rate of inflation is now up by 1.87%, indicating easing inflation pressures in contrast with the 4% pace of core inflation during the first six months of the year.
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This data is consistent with a strong and growing economy bolstered by income gains above the inflation rate and a dynamic labor market.
On the back of this data, along with the 5.4% increase in November durable goods orders released on Friday, we are lifting our fourth-quarter estimate of gross domestic product to 2.8% with risk of a faster pace closer to 3%,
Policy implications
The policy implications of Friday’s data suggest that the Federal Reserve will, for the fourth straight time, keep rates steady at its January policy meeting as it continues to shape investor expectations around what we estimate will be four 25 basis-point cuts that will start around midyear.
The improvements in both top-line and core inflation are in line with our year-end target of 2.5% for both metrics.
While it is possible that top-line and core inflation could improve in a more notable way between now and the March policy meeting, we think that current market pricing of a 77% probability of a 25 basis-point rate cut at that meeting looks unlikely.
The data
Overall compensation increased by 0.6% in November and by 6.3% over the past year, while wages and salaries advanced by 0.6%. Disposable income increased by 0.4% on the month.
The savings rate increased to 4.1% amid a 2.6% three-month annualized pace in personal spending. Personal income excluding government transfers increased by 0.6% and was up by 2.9% from a year ago.
Inside the PCE inflation data, energy prices declined by 2.7% and food prices fell by 0.1%. Goods prices declined by 0.3%, driven by a drop of 2.1% in durables and a 0.7%% increase in nondurables. Demand for services resulted in a 4.1% increase in those prices.
The takeaway
The American economy is closing out the year on a strong footing driven by real income and spending gains and easing growth in inflation.
The underlying pace of inflation over the past half year now strongly implies that inflation is at or approaching tolerable levels, which should translate in to continued inflation-adjusted wage gains that will sustain the economy throughout the next year.
The improving inflation outlook is part of a larger economic mosaic that is creating the conditions in which the Federal Reserve can begin a series of rate cuts that we think will start in the middle of next year and bring the policy rate down to a range between 2.5% to 3% over the next three years.
The probability of rate cuts will almost surely continue to bolster the risk appetite across asset markets, which will provide a tailwind to overall household consumption next year.
