Consumers tapped savings to buoy spending

January 26, 2024

Personal disposable incomes rose 0.1% after adjusting for inflation in December. That is weaker than upwardly the revised 0.5% increase of November. The slowdown in incomes did not discourage consumers, who tapped into their savings to boost spending.  

Consumer spending rose at a 0.5% percent pace after adjusting for inflation in December, the same as we saw in November after revisions.  That is tied for the strongest gain since July. The jump was driven by a surge in spending on goods, including vehicles. Spending on services increased but at a slightly slower pace than we saw in November. Spending on insurance is picking up with an escalation in everything from health to home and vehicle premiums.

The saving rate dropped to 3.7% in December from 4.1% in November. The drop in savings is showing up in an increase in the used of credit cards, which were paid down earlier in the recovery. Unpaid balances are compounding much more rapidly now, given the surge in credit card rates. 

Consumer attitudes improved in December and early January, although their attitudes about the economy have not been a hurdle to spending. They reflect a complex mix of emotions, not the least of which includes the roller coaster of surviving a pandemic and the inflation that ensued. People don’t just want to regain ground lost to inflation. They would like to gain ground in their living standards; that takes time.

The personal consumption expenditures (PCE) index rose 0.2% in December, after dropping by 0.1% in November. That translates to a 2.6% increase from a year ago, the same as November. A drop in goods prices, including energy, was more than offset by an increase in service sector prices.  

The core PCE index, which strips out food and energy, also rose 0.2% with rounding in December. That translated into a 2.9% gain from a year ago, down from the 3.2% pace of November. The three- and six-month annualized pace, which reflects momentum, has already hit 2%.

The Federal Reserve has been waiting for core PCE, which is the best predictor of future inflation, to dip below the 3% threshold, convincingly, before cutting rates. The goal is to cut before inflation reaches its 2% target on a year-over-year basis to avoid overtightening and an unnecessary increase in unemployment.

The Fed must weigh the risk of causing undue pain by holding rates too high for too long, given the progress made on inflation, with the risk of cutting too rapidly and potentially reigniting the cooling embers of inflation. This is at the same time that supply chain fragilities are picking up. The attacks on ships in the Red Sea and low waters in the Panama Canal have already increased shipping costs. However, this is not 2021: Demand is weaker, while manufacturing capacity is plentiful and not constrained.

The pickup in productivity growth and slowdown in growth abroad are additional factors to be weighed. The risk of reigniting inflation is not as great as it was earlier in the recovery.