Posted by Jeffrey J. Roach, PhD, Chief Economist
Friday, June 30, 2023
Key Takeaways:
- Real consumer spending was stagnant in May after only a modest gain in April as consumers slowed spending habits.
- The savings rate rose to 4.6%, the highest since January last year, indicating consumers are slightly more cautious.
- The Federal Reserve’s (Fed) preferred inflation metric eased in May, slowing down to 3.8% from a year ago.
- Services inflation is still running above 5% year over year, but as consumers near the end of their spending splurge, we expect services inflation to ease, but it may take a couple of quarters before the markets see this category materially improve.
- The spending splurge is likely nearing the end as consumers released most of their pent-up demand for spending. However, the services economy will likely experience a bit more upside from consumer spending in the near term but aggregate demand will likely cool later this year.
- As consumer spending cools, we expect inflationary pressures to ease further throughout the balance of 2023. From a global perspective, the domestic inflation environment is materially better in the U.S. than for our international counterparts.
Consumer Spending Stalls
Consumer spending, adjusted for inflation, was unchanged in May as consumers pulled back demand for durable goods. Investors should see this as the setup for a downshift in consumer activity for the remainder of 2023.
The details of the report are revealing. Real spending on motor vehicles and parts declined over 4% from the previous month, the largest monthly decline since November and an indicator that auto dealers will likely have a rough time heading into the third quarter. Spending on utilities declined as electricity prices fell for the third consecutive month. As rent prices and utility prices ease, we expect some relief for the lower income consumer who has felt the biggest impact from the current inflationary environment.
In contrast to the durable goods space, consumer demand for services is still evident. Services spending rose as individuals travelled extensively in May, despite high transportation prices. It seems there could be a few more months of healthy demand for services such as travel and recreational services. A longer term trend is emerging for growing demand for financial services, including portfolio management and investment advice. When markets are volatile, retail investors want advice and the recent global events reminded consumers about the value of professional counsel. Real spending on advisory services grew over 10% from a year ago, the second consecutive month of double-digit gains.
Getting Cautious?
The savings rate ticked up in May, as consumers seem to be increasingly cautious about the economic outlook. Consumers saved 4.6% of their personal disposable income, the highest since January 2022. The savings rate is still historically low as consumers have a surplus stock of savings. However, the flow of consumer activity seems to suggest the persistence of inflation, the unknowns within regional banking, and the hawkishness of global central bankers which are likely putting a damper on consumer confidence.
Inflation is Easing
The Fed’s preferred inflation index, the Personal Consumption Expenditures (PCE) price index, rose 0.1% from the previous month, pulling the annual rate of inflation down to 3.8%. As base effects will pull the annual rate even lower, investors should look at the annualized 3-month change in inflation which fell to 3.2%. Clearly, the Fed will see this as welcomed news and could become less hawkish in the coming months if consumer demand falls. Fed Chair Jerome Powell has popularized looking at the inflation dynamics of core services excluding housing and as shown in the matrix below, this annual rate rose 0.2% in May, the smallest rise since July 2022, pulling the annual rate to 4.5%.
Investors will not likely see inflation converge to the central bank’s long run target of 2% until demand for services cools off. As shown in the chart below, consumer spending on goods is significantly above trend, but services spending is slightly below trend.
Summary
The spending splurge is likely nearing the end as consumers released most of their pent-up demand for spending. However, the services economy will likely experience a bit more upside from consumer spending in the near term but aggregate demand will likely cool later this year. Investors may want to look for opportunities within some of the discretionary sectors, such as the leisure and hospitality sector and the luxury goods sector.
As consumer spending cools, we expect inflationary pressures to ease further throughout the balance of 2023. From a global perspective, the domestic inflation environment is materially better in the U.S. than for our international counterparts.
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