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Inflation looks sticky

Consumers discouraged by inflation.

The personal income and outlays report was disheartening. Persistent inflation and concerns about the future caused consumers to save more and hold spending in check in March, despite additional gains in disposable personal income. 

Personal disposable incomes rose 0.3% after adjusting for inflation in March, an acceleration over the 0.2% pace of February. Employment posted solid if not spectacular gains during the month, which helped blunt the blow of persistent inflation. 

Personal consumer expenditures were flat after adjusting for inflation in March, after falling a downwardly revised 0.2% in February. January was revised down as well but remains the strongest month of the quarter, with a 1.4% jump. That confirms that the surge in spending that we saw in the first quarter was front-loaded and buoyed by a record bump in Social Security payments in January. 

Gains in services offset further declines in spending on goods. That is the second round of back-to-back declines in six months. We saw spending contract during the height of the holiday season in November and December. The ranks of those unable to work and out on vacation hit another record according to the employment report in March. That helped buoy spending on services along with a rise in spending on health care.   

The only saving grace was the personal saving rate (pun intended), which soared to 5.1% in March, and was revised up to 4.8% in February. That is a strikingly large move from the low of 2.7% hit in June 2022, which marked the peak in inflation last year. The saving rate was still in the 3% range at the start of the fourth quarter. That could provide consumers with a cushion as employment slows, as we move into summer. It also underscores the caution consumers are feeling about the economy as we move into summer.

Consumer sentiment deteriorated a bit in March and early April in response to concerns about inflation and the prospects for a recession. Higher income households were affected more by layoffs and volatility we saw in financial markets than lower income households according to the breakdown of the University of Michigan sentiment index.  

The PCE price index rose 0.1% in March, after rising 0.3% in February. A drop in both food and energy prices helped to moderate overall inflation during the month. The core PCE (excluding food and energy) index rose 0.3%. Gains in core services, which strip out shelter and energy costs and have become a focus of the Federal Reserve, rose 0.2%. That compares to a 0.3% rise in February. 

Health care, restaurant, childcare, hotel room and vehicle insurance costs all accelerated during the month. Airfares were unchanged, while rental rates on vehicles dropped. Fees on portfolio investment dropped, likely in response to the financial market turmoil we endured during the month. 

The core PCE index rose 4.6% from a year ago in March, after rising 4.7% in February. February inflation measures were revised up. The core PCE index jumped at a 4.9% annualized pace in the first quarter, after cooling to a 4.4% rate in the fourth quarter.   

The core services PCE index rose 4.4% from a year ago in March, after rising 4.7% in February. The core services PCE index rose at a 5.1% annualized pace in the first quarter, close to the 5% rate of the fourth quarter. 

The acceleration in the quarterly data on core inflation measures is worrisome, as it suggests that underlying inflation is getting sticky. Moreover, much of the deceleration that we saw in March is likely to be reversed because it was concentrated in fees on financial services, which have likely bounced back with overall financial market conditions.

Wage costs buoyed by benefits

The employment cost index (ECI) rose 1.2% in the first quarter, up from 1.1% in the fourth quarter. That translates to 4.8% on a year-over-year basis, versus 5.1% in the fourth quarter. A sharp acceleration in the ECI a year ago helped to temper year-over-year gains.  

The ECI accelerated at a 4.9% annualized rate in the first quarter, after rising at a 4.5% pace in the fourth quarter. All the acceleration of the ECI on a quarter-to-quarter basis was driven by a surge in the costs of benefits, not wages. 

Professional business services, construction and other services (including childcare) all were outliers. Compensation in those sectors is accelerating on both a year-over-year and quarterly basis. Accountants remain in particularly short supply in the professional businesses sector. 

Health care, restaurant, childcare, hotel room and vehicle insurance costs all accelerated during the month.

Everything from health care costs to increased paid time off has risen, as employers have sought to attract and retain workers over the last two years. The large tech firms have been more aggressively managing those costs, with high-profile layoffs announcements. 

Those layoffs began to show up in the initial unemployment claims which hit a trough for the current cycle in September 2022, and have moved back above the 2019 average in recent weeks. Most states do not allow those who get a monthly severance to apply for unemployment benefits until that severance runs out. Those workers are also counted as employed as they continue to show up on payrolls. 

The most recent increases in unemployment insurance are among higher paid individuals. That reflects layoffs of salaried workers at larger firms, many of which were the largest beneficiaries of the pandemic-induced boom in spending on electronics, homes and everything to fill them with. 

Bottom Line

The monthly data on incomes, consumer spending and inflation revealed some caution, with consumers pulling back on spending, mostly goods. The rise in the saving rate is another sign of caution amidst what had become a more persistent rise in inflation and concerns about a recession. The volatility in financial markets that we saw in March no doubt fueled those fears. The data is not as reassuring as it could be for the Federal Reserve, as it confirms their fear that inflation is getting sticky. The annualized data suggests core inflation and employment costs accelerated.  

The monthly data on inflation decelerated a bit but one month does not trend make. The quarterly data suggest that the underlying momentum in inflation picked up in the first quarter, which is the wrong direction for the Federal Reserve. Employment costs also picked up on an annualized basis, which could create a tailwind for inflation in the second quarter. The forecast for a quarter point rate hike at the Fed meeting next week holds. Some on the Fed may be reluctant to signal a definitive pause in rate hikes, given the persistence of inflation.  

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Meet our team

Image of Diane C. Swonk
Diane C. Swonk
Chief Economist, KPMG US

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