 |
| Consumer spending fell in both November and December, the Department of Commerce said on Friday. Hiroko Masuike |
The US economy has faced two fundamental and complex challenges for more than a year.
Both trends are now showing early signs of reversal.
Consumer spending fell in both November and December, the Department of Commerce said on Friday.
Inflation is also easing. According to the Federal Reserve's recommendations, consumer prices rose 5% his year through December. It was considerably faster than usual, but it was the slowest pace of the year.
Taken together, these numbers show how the economy will eventually boil over. From the Federal Reserve's perspective, this is good news. Central banks have aggressively raised interest rates over the past year, forcing both consumers and businesses to cut spending. There is growing evidence that these efforts are paying off.
"They're on drugs. 'The economy is on the right track,'" said Sarah Watt House, senior economist at Wells Fargo & Co.
But the road is uncertain and narrow. So far, the Fed has been successful in cooling the economy without hampering the recovery or significantly increasing unemployment. However, the full effect of that action has yet to be felt.
Policymakers are expected to raise interest rates another quarter of a percentage point at next week's meeting, to a range of 4.5% to 4.75%. This suggests that central banks expect borrowing costs to remain high for some time, even if they stop raising rates.
Many forecasters do not believe the Fed will be free to lower inflation without triggering a recession.
There is also the opposite risk. The recent slowdown in inflation and spending, while encouraging, could still be reversed. For example, the labor market remains strong and may continue to stimulate the economy.
“There are early signs that the Fed should be watching,” said Matthew Lucetti, chief U.S. economist at Deutsche Bank Securities. "It's just started and I don't know how long it will last."
Data released on Friday showed consumer prices rose 0.1% in December for the second straight month and 5% year-on-year. This measure, the Personal Consumption Expenditure Price Index, is related to the well-known consumer price index and is the Fed's preferred measure of inflation.
After the food and fuel strip, the price index rose 4.4% year-on-year, slowing from its 4.7% in November. This is in line with what economists predicted in a Bloomberg survey.
Private consumption fell by 0.2% in December, and the government had originally reported a slight increase in consumption in November but was revised to show a slight decline.
Income continued to grow, reflecting a solid job market. But instead of spending the extra income, Americans chose to increase their savings. This suggests that people may become more cautious amid news of layoffs and a possible recession. Households as a whole still have hundreds of billions of dollars in savings accumulated during the pandemic, but that cushion is shrinking.
"Overall, this is a sign that consumers are becoming more cautious," House said. “Consumers are starting to shrink.”
The data is consistent with anecdotes that suggest consumers are becoming more sensitive to price increases after months of free consumption.
Apparel chain Express, for example, is making women's clothing buyers cost-conscious again. The company's CEO Timothy Baxter said on its December earnings call that the company was working on it.
"We are rebalancing our product range and reintroducing more starting prices," Baxter said.
But he noted that price-sensitive returns aren't accurate across the board: demand for contemporary tailored jackets, for example, is strong.
“We saw very little price resistance because the value we offer in these categories is so good,” he said.
Friday's data is one of the last readings on economic conditions the Fed will receive before announcing next week's interest rate decision.
Central banks are watching labor market and spending trends closely to try to guess how many more policy adjustments are needed and how long interest rates need to stay high. Federal Reserve interest rate moves work by slowing the job market and keeping demand down. As a result, businesses are forced to raise prices more slowly to avoid losing customers.
This is why every new data point on spending is so important. The central bank will receive another key piece of information about the economy on Tuesday when the labor cost index is released on the eve of policy decisions. The numbers should give a sense of whether wage growth is slowing or going at a rapid pace.
In a speech last week, Fed President Christopher Waller said he expects the recent improvement in headline and core inflation to continue. It's a stream of
Waller added, however, that the recent economic data are encouraging, making it more likely that the Fed will gradually slow the economy and inflation without triggering a painful recession.
