The long-awaited Personal Income and Outlays report for December was released last Friday. This piece produced by the U.S. Bureau of Economic Analysis contains information about personal income, savings rates and very importantly the Personal Consumption Expenditures (PCE) price index, the Fed’s preferred inflation gauge of the economy. The release brought something for everyone in our opinion.
The hawks would have seen their views supported by the very strong spending data. Personal spending was up 0.7%, matching last September’s move on the podium for the strongest monthly figure in a year. Spending in goods growth outpaced that of services but both were robust. Personal income was in line with expectations and grew 0.3% in the month; below the 0.4% recorded in November. The savings ratio therefore declined to 3.7%, the lowest figure in 12 months. It is hard to argue that there is much need for rates to be cut just by looking at these numbers. The economy in the U.S. has slowed from the abnormal growth rates seen in Q3 2023 but remains very strong indeed. Savings rates of 3.7% are below those pre pandemic. It is quite challenging to reliably estimate the amount of excess savings consumers hold at this juncture, but it is fair to say that the data points towards these savings not being depleted yet.
The doves on the other hand would argue that PCE deflator numbers are consistent with inflation actually being very close to target. The MoM PCE deflator and Core PCE deflator both came at 0.2%. If we take shorter time frames’ annualised numbers such as the 3-month annualised, we rapidly conclude that this is below the 2% target. Core goods inflation was significantly negative at -0.27% while core services came in at a less cheerful 0.33% in the month. If these monthly rates are sustained, PCE inflation will be at target in only a few months’ time.
The next FOMC meeting is this Wednesday with the probability of the first cut of the cycle at close to zero. The implied probability for a March cut is currently at 51% and this has fluctuated wildly in the last few weeks. By the end of December, the figure was 90% and has since receded as the Fed sought to partially undo Jerome Powell’s dovish press conference in December. It will be interesting to see if and how the Fed change their rhetoric regarding future policy. At some stage they need to acknowledge more clearly that the inflation picture is a lot more favourable and that rate cuts are likely.
We think the PCE data confirms that rate cuts are coming in the not-so-distant future. We are less certain, though, that this is as close as a few weeks’ time at the March FOMC meeting. With growth and consumption in particular holding up very well in the face of monetary policy tightening there is less of a hurry for the Fed to cut rates. After inflation turned out to be less transitory than they projected, we think it is quite reasonable they would wait to have a little bit more clarity before embarking in an easing cycle. The direction of rates though seems to be clear, and the chances of a hard landing continue to recede for now.