Fed’s favored inflation measure remains elevated

March 29, 2024

The personal consumption expenditure (PCE) index rose 0.3% in February, slightly slower than the revised 0.4% pace of January. The overall PCE edged up slightly to 2.5% from a year ago compared to 2.4% in January. The three- and six-month annualized paces, which better measure momentum, were more worrisome for the Federal Reserve. The three-month moving average rose at a 3.4% annualized rate in February, well above the 2% pace of last month. The six-month moving average edged down to 2.5% versus 2.6% last month. The data for January were revised up. 

The core PCE index, which strips out oil and energy, rose 0.3% in February after jumping 0.5% in January. The index rose 2.8% from a year ago, after an upward revision to 2.9% in January. Momentum on inflation moved in the wrong direction for the Fed. The three- and six-month moving averages rose to 3.5% and 2.9% respectively during the month, up from 2.8% and 2.6% in January. 

Finally, the super core for services, which strips out shelter costs, rose 0.2% in February, a slowdown from the sizzling 0.7% jump in January. The index was up 3.3% from a year ago, after rising 3.5% in January. The three-month annualized pace moved up to 4.5%, after being revised up to 4.5% in January. The six-month annualized pace rose 3.8% versus 3.5% last month.

In late 2023, the three- and six-month annualized paces of inflation slowed to 2%, which prompted many to declare the battle against inflation won. Calls for rate cuts mounted. The Fed pushed back, worrying that the final mile on inflation would be littered with potholes; today’s data confirm that fear. The Fed believes that it is at a peak in rates but a significant minority - 9 of 19 - who participate in the Fed’s deliberations, is projecting two or fewer rate cuts for 2024 and pushing the median trajectory on rate cuts more towards two rather than three cuts in 2024.

Higher prices at the gas pump, higher import prices, notably in goods prices, and a bump in service sector inflation all added to inflation pressure in February. The rise in import prices and reversal in goods inflation is something the Fed has been watching. It fears that the low-hanging fruit from healing supply chains and dropping goods prices may have been plucked, while service sector inflation is beginning to look sticky. 

Spending soars

Consumer spending rose 0.4% after adjusting for inflation in February, the strongest pace since December. The January data was revised down slightly, but the consumer is still going strong. Spending on goods rebounded, buoyed by a jump in vehicle sales, while spending on services remained strong. Travel and spending on recreation were particularly strong. Casino gambling soared, on the heels of the Las Vegas Super Bowl and legalized sports gambling. The number of celebrities in addition to Taylor Swift at the Super Bowl was stunning.

Another notable increase was a surge in spending on mass transit. It was the strongest monthly pace since September 2020. That suggests that people were returning to urban centers as they traveled, even as the return-to-work figures plateaued.

Personal disposable incomes fell 0.1% after adjusting for inflation in February, after flattening in  January. The saving rate, which is a residual of incomes less consumer spending, fell to 3.6%, since December 2022. Back then, consumers were draining savings to cushion the blow of inflation. Now, the mood appears to have shifted to sustain robust spending, despite the crimp of higher rates and the persistence of high price levels. The consumer credit data are likely to show a pop in credit card usage for February. 

Separately, net worth had picked up for roughly two-thirds of households that own stock and homes. That has prompted them to spend more of their incomes. A recent San Francisco Fed blog estimated that wealth has risen by $27 trillion more than if we had stayed on the trend we were on during the late 2010s.