Consumers spent with abandon at year-end

January 31, 2025

Personal consumption expenditures jumped 0.4% after adjusting for inflation in December, following upward revisions to the previous two months. Gains in spending on big-ticket items helped propel those gains during the entire quarter. That largely reflects the surge in replacement demand associated with the damages caused by Hurricanes Helene and Milton.

Many speculate that consumers bought ahead of tariffs, given the shift in consumer sentiment in December. However, the upward revisions to gains earlier in the quarter suggest that the surge was more the result of replacement demand than a fear of tariffs. Spending on big-ticket items that could be most affected by tariffs accelerated the most in November, before consumers mentioned concerns about inflation in the sentiment survey.

Gains in spending were broad-based and included more nondurable goods and services as well as big-ticket items. Spending on clothing, which had been weak, made a robust comeback in December. Replacement demand and the abbreviated holiday shopping season pushed spending into the last month of the year.

Disposable personal incomes rose 0.1% after adjusting for inflation in December, close to the pace of November. The shortfall between income and spending was filled by a drawdown in the personal savings rate, which plummeted to 3.8%. That is the lowest pace for savings since December 2022, when consumers were dipping into savings to deal with a blistering bout of inflation.

A surge in both real estate and financial wealth to record highs fueled spending in recent years. The credit data from the Federal Reserve reveals that households have been tapping their home equity lines of credit (HELOCs) for six consecutive quarters through the third quarter of 2024.

The data for the fourth quarter is not out yet, but likely to show that the pattern continued. Homeowners can arbitrage the lower rates that they can get for HELOCs versus other forms of credit, including vehicle loans. Separately, insurance payouts following the damages from hurricanes show up as a drain in saving when they are spent.

Inflation edged up

The personal consumption expenditure (PCE) index, which the Federal Reserve targets as its preferred inflation measure, rose 0.3% in December, after rising only 0.1% in November. The index rose 2.6% from a year ago, still above the Fed’s 2% target and a slight acceleration from the pace of November. Both food and energy prices picked up in December. The bird flu has wreaked havoc on chicken stocks and egg prices, while additional sanctions on vessels shipping Russian oil have boosted oil prices.

The PCE is expected to slow as we round the corner of the year and move into the start of 2025, at least on a year-over-year basis. Inflation accelerated a year ago, which makes for easier year-on-year comparisons. Revisions to the seasonal adjustment of the data at the start of the year should help, as that could suppress the month-to-month move in the index.

The core PCE, which excludes food and energy, rose 0.2%, which is a slight acceleration from the 0.1% pace of November. The core PCE held at a 2.8% increase from a year ago in December, the same as October and November after rounding. That is a slight tick up from the 2.7% pace during the summer months.

The super core services PCE, which excludes shelter and energy costs and gets to underlying service sector inflation, rose 0.3%. That is up from 0.2% after rounding in November. A record jump in airfares during the month contributed to those gains. December was a record month for travel. The number of people out on vacation in the household survey soared for the month. The data go back to 1976. Travel on all fronts hit a new high for the holiday break, which spanned December 21 to January 1, 2025.

The super core services index rose 3.5% from a year ago in December, the same as October and November. Those gains point to a slight acceleration from the 3.3% annual pace in the third quarter, still well above the pre-pandemic norm of about 2%.

The stickiness of service sector inflation and an acceleration in consumer spending is why the Federal Reserve decided to move to the sidelines in January. It has already cut a full one percent from short-term rates since September and doesn’t want to risk reigniting inflation. The last mile on inflation has proven to be long and littered with potholes.