The economy was much stronger than expected in February as data on both spending and inflation exceeded forecasts.
Spending rose by 0.8% on the month while the personal consumption expenditures index came in at 0.3% for both the overall and core readings,
Spending rose by 0.8% on the month, compared with the forecast of 0.5%, while the personal consumption expenditures index—an inflation measure closely watched by the Federal Reserve—came in at 0.3% for both the overall and core readings, compared with the 0.4% forecast for overall inflation.
That reading put the Fed’s key inflation gauge at 2.5% on both a 12-month and six-month annualized basis, which is more than tolerable for the Fed to begin thinking about cutting rates.
In addition, the supercore PCE rate, which measures services excluding housing and energy, rose by only 0.18% on the month, down sharply from 0.66% in January.
Even as January’s data was revised slightly down, it only reaffirmed our call that January’s surge in inflation and disappointing spending data were aberrations because of the holiday spending hangover and seasonal fluctuations in the data.
January’s readings were 0.4% for overall PCE inflation, and 0.5% for core inflation, both up by 0.1 percentage point.
Based on these surprises, our gross domestic product tracking model is pointing to a 2.2% increase for the first quarter, up from 2.1% previously. January’s downward revision to real spending and a slightly higher trade deficit offset some of the impressive growth in February.
Given Friday’s data, we are more than comfortable with our call for a June start for rate reductions, with a total of three this year. Both inflation and growth trajectories are moving toward the forecast we made in December.
Personal income and spending
The bad spot from the report came from income, which rose by 0.3% on the month, down from 0.8% earlier, and slightly off from the forecast of 0.4%.
With inflation running high in the past two months, real disposable income posted the first decline in five months.
There is no denying that the labor market remains strong. But the surge in immigration over the past two years has implied that the equilibrium for job gains is closer to 200,000 a month instead of the 100,000 previously thought. That means the labor market is softer than it has been perceived.
In a sense, that is good news for wage inflation. But it also puts some pressure on the Federal Reserve to begin cutting rates soon to sustain growth.
The main driver of spending growth was automobiles, which grew by 3.9% and 3.8% on a nominal and real monthly basis, respectively.
Read more of RSM’s insights on the economy and the middle market.
Goods spending rebounded in February, rising by 0.5% and 0.1% on a nominal and real monthly basis, respectively. Services grew by 0.9% and 0.6% on a nominal and real monthly basis, respectively.
The savings rate fell to 3.6% from 4.1% previously, despite lower income growth. That suggests consumers are continuing to spend down their excess savings, which will most likely run out by the summer.
The takeaway
Friday’s data painted a brighter picture of the economy as it inches closer to a soft landing. But it is important not to ignore the weaknesses in the income and savings data that seems less promising for future spending.
Rates have been restrictive and will continue to be restrictive even after two or three cuts. It means the Federal Reserve should be slightly more dovish in our opinion to maintain growth above the long-term trend level of 1.8% throughout the year.
