This commentary is written by PNC Chief Economist Gus Faucher.
- After-tax personal income rose 2.0% in January, with consumer spending up 1.8%.
- Overall core and PCE inflation were both 0.6% in January, an acceleration from recent months. There were also upward revisions to inflation at the end of 2022, and inflation is still much higher than the Fed would like.
- Upward revisions to personal income in the second half of last year are good news for consumer spending in early 2023.
- The FOMC will continue to increase the fed funds rate in the near term, and a U.S. recession is likely in the second half of this year.
There were large gains in inflation-adjusted after-tax income and consumer spending in January after some softness at the end of 2022. But inflation picked up in January, and the Federal Reserve will continue to increase interest rates in the near term. One big positive from the report is that personal income was revised much higher in the second half of 2022, meaning that households have more spending firepower than previously thought.
Nominal personal income rose 0.6% over the month, a smaller than expected increase. But with a big drop in tax payments in January, after-tax income jumped 2.0% over the month.
Consumer spending rose 1.8% before inflation in January from December, following two months of small declines. Durable goods purchases jumped more than 5% despite higher interest rates, and there were also gains of better than 1% for services and nondurable goods.
In addition, there were large upward revisions to income growth in the second half of 2022 as the Bureau of Economic Analysis incorporated more complete payroll records. Personal income was about 1% higher in December with the revisions than previously reported, and the savings rate was revised much higher, a big positive for the consumer outlook.
But inflation picked up in January. The personal consumption expenditures price index increased 0.6%, the biggest increase since June 2022. The core index, excluding volatile food and energy prices, was also up 0.6%, the biggest increase since August. And there were also upward revisions to inflation at the end of 2022. As a result, the inflation picture looks quite different from one month ago, with overall inflation stuck above 5% in late 2022/early 2023, and core inflation somewhat under 5%. Both of these are much higher than the Federal Reserve’s 2% objective, and the central bank will continue to raise short-term interest rates in early 2023 to cool off economic growth and slow inflation.
Even with high inflation the January numbers for real after-tax income (up 1.4%) and real consumer spending (up 1.1%) were very good. The increase in real consumer spending followed small declines in both November and December.
The economy is holding up in early 2023, after some softness at the end of 2022. Job growth was very strong in January, income growth remains good, and consumer are continuing to spend. In addition, the upward revision to the savings rate is very good news for near-term consumer spending growth: households are in better financial shape than previously thought. But the drag from higher interest rates as the Fed continues to tighten monetary policy will take a larger toll on the economy in the near term, particularly on consumer spending on durable goods.
With inflation running much higher than the Federal Open Market Committee would like, PNC expects the committee will raise the fed funds rate by 25 basis points at each of its next two meetings, in mid-March and early May. With further monetary tightening coming, PNC expects a mild U.S. recession in the second half of this year.
Wages and salaries rose 0.9% in January thanks to very good job growth and solid wage gains. And transfer receipts jumped 1.5% as Social Security benefits rose due to a big cost-of-living adjustment after high inflation in 2022. But other components of income growth were softer, and contributions for social insurance (primarily payroll taxes) jumped 1.5% in January. But there was an almost 8% decline in tax payments in January from December, boosting after-tax income.
With the large gain in after-tax income, a smaller increase in spending, and the large upward revisions to income in previous months, the picture of household saving has changed dramatically. After the December release the saving rate was reported as 3.4% in December, and below 3% in every month from August to November. But now the saving rate was 4.7% in January, 4.5% in December, 4.0% in November, and between 3.0% and 3.5% in July through October. Thus, household saving is in much better shape than previously thought, which is very good news for the near-term consumer outlook.
On a year-ago basis PCE inflation was 5.4% in January, up from the 5.0% in December before revisions. Similarly, reported year-over-year core PCE inflation jumped to 4.7% in January, from 4.4% in December before revisions.