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Consumers move sideways

Inflation slowed down in May.

Personal consumer expenditures were flat after adjusting for inflation in May, a slight slowdown from the 0.2% gain in April. Data for April was revised down but was still strong. The consumer is on track to post solid, if not spectacular, gains in the second quarter following a sharp acceleration in the first quarter. A record 8.7% bump in Social Security payments for some 66 million Social Security recipients helped to buoy spending in the first quarter. Solid employment gains and falling prices at the gas pump played a larger role in recent months.

The pivot away from goods into services continues. A double-digit surge in spending on services, including medical and travel, exactly offset a double-digit drop in spending on goods. TSA throughput exceeded 2019 levels during the Memorial Day weekend, while the ranks of those unable to work due to a vacation came close to another record high for the month.

Real personal disposable incomes rebounded at a 0.3% pace in May, after contracting 0.1% in April. Again, data for April were revised down. Incomes outpaced spending, which pushed the saving rate to 4.6%. That is up slightly from the 4.3% pace of April but matches the levels we saw in March.

The next shoe to drop will be to determine how resumption of student loan payments could impact saving and spending. It’s a good bet that those who haven’t paid a monthly student loan payment for three years are no longer budgeting for it. Brace for a drop in the saving rate and constraints on spending as student loan payments resume.

We still have a September hike penciled in, but that seems an eternity in this economy.

Inflation cools

The personal consumption expenditure index (PCE) rose a tepid 0.1% in May, a sharp slowdown from the 0.4% pace of April. That translates to a 3.8% increase from a year ago, nearly half of the 7% peak in June 2022. The largest contributor to that slowdown is a drop in energy prices, notably at the gas pump. Other goods prices have begun to cool. 

The core PCE (ex-food and energy) rose 0.3%, slightly behind the 0.4% pace of April. That translates to a 4.6% increase from a year ago, a range it has been stuck in since last December.

The core services PCE (excluding rents), which the Federal Reserve is now watching more closely, rose a more moderate 0.2% in May, half the pace of April. That is the slowest monthly increase since July 2022. The annualized rate for May alone was 2.8%, which is stunningly low, but one month does not a trend make. Core services rose 4.5% from a year ago, close to the pace of the last seven months. The index dropped to a 3.9% three-month annualized rate in May, the first time it was below 4% since September 2022.

The question for the Fed is whether core services inflation can continue to improve given the surge in demand for services over goods. The level is still elevated but moving in the right direction in May.

Bottom Line:

Consumer spending moved sideways, despite lower prices at the gas pump in May while savings moved a bit higher. Inflation cooled, which will provide only marginal solace for the Fed. It does not want to reignite the hot embers of service sector inflation, which is possible if we don’t see some cooling of demand in the service sector over the summer. A moderation in revenge travel will help. (One has to wonder how much vacation time those who get paid leave have left.)

The Fed is expected to raise rates again in July as a hedge against another move up in core inflation. We still have a September hike penciled in, but that seems an eternity in this economy.

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Meet our team

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

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