Aug Personal Income & Outlays: Household Strength Continues

Wage income growth was revised up a lot and spending remains strong. Underlying inflation rates moved closer to 2% in the near term.

The August Personal Income and Outlays report provides a good insight on the U.S. consumer as well as inflationary pressures going forward. This note presents some of these insights.

Key takeaways:

• Personal income growth out of wages and salaries was revised up substantially for most of 2024. Household wage income growth now notably overshoots the pace that’s consistent with 2% PCE inflation over the medium-term.

• The stock of excess savings has NOT run out and continues to be a tailwind for consumption. Between July and August, it fell around $12 billion and equaled about $407 billion in August.

• As in the previous month, in August headline consumption growth ran well above its underlying spending growth. Over the coming months headline spending will likely ease towards the pace of underlying consumption growth. But given strong household wage income growth and still sizeable excess savings, this likely does not signal that a large downshift in consumption is forthcoming over the next six months.

• Core services excl. housing PCE inflation, the Fed’s favorite gauge of underlying inflation, continues to head in the right direction, for now. The central tendency measures of PCE inflation are similarly slowing over the near term and are closing in on 2%. Over an annual horizon, underlying inflation still remains above target.

• The slowing in underlying inflation measures will no doubt give most Fed officials comfort that cutting policy rates was the right move. Given strong wage income and consumption growth rates the Fed will likely, for now, pursue a gradual rate cutting path.

Much Stronger Wage Income Growth

A lot of the news in today’s release was, like last year, due to the annual comprehensive benchmark revision of the recent past. And like last year this meant a marked upward revision to growth of household income out of wages and salaries.

The year/year wage income growth rates throughout 2024 were revised up notably with, e.g., June and July revised up from 3.8% and 4% previously to 6.4% and 6.3% in the current vintage (blue vs orange lines, chart above). Over the month wage income growth in August remained broadly unchanged at 6.3%.

To interpret wage income growth trends, I earlier proposed to compare wage income growth with a neutral benchmark growth rate based on trend non-farm business sector (NFB) output growth and either the abovementioned common inflation expectations factor or the 2% Fed inflation target. Similar to what I did when discussing wages and inflation expectations in my October 2023 update, I now also incorporate trend labor share growth into this neutral benchmark.

Any deviation in actual household wage income growth above or below the aforementioned inflation target-consistent neutral benchmark means household wage income growth outpaces or cannot sustain in the medium term the 2% inflation target.

The chart above shows that with the large upward revisions to wage income growth, the interpretation of wage income growth trends also changed a lot. Based on the previous data vintage wage income growth was broadly consistent with a pace in line with the Fed’s inflation target over the medium term (orange line, chart above). The revised data, however, now signals a notable wage income growth gap vs the 2% inflation target pace, with this overshoot in August reaching its highest level since mid 2022 (blue line, chart above). This brings this measure more in line with the above-inflation target wage growth rates I have been signaling over the last couple of labor market reports.

With nominal wage income growth thus overshooting the pace consistent with the target in the medium term, household spending growth could be disrupting a sustainable return of inflation to 2% over a longer horizon.

Households Excess Savings Lower but Still Sizeable

Household spending was up 0.2% over the month in August, with disposable household income also growing 0.2% for the same period. As a consequence, the savings rate remained broadly unchanged at 4.8% in August compared to 4.9% previously (upwardly revised from 2.9%).

The benchmark revisions also led to higher than previously estimated (trend) savings rates. The chart above shows that after these revisions the savings rate is now only slightly my trend savings rate estimate of 5.5% in August using the ‘average of trend’ approach outlined in my earlier excess savings note (orange line). This trend savings rate estimate remained unchanged from June and July (which were upwardly revised from around 4.5% for both months using the previous data vintage). Both remain below trend savings rate assumptions used elsewhere (grey and yellow lines). As last month, my trend savings rate estimate does seem to have stabilized, now at around 5.5%, as declining inflation uncertainty means households have less of an incentive to dissave over the medium term.

Given the upward revision in my trend savings rate estimates as well as upward revisions to consumption spending (which I will discuss below), the level of excess savings were revised down. In August cumulative excess savings declined from $419 billion in the previous month (revised down from $529 billion) to about $407 billion (see chart above).

Above-trend growth in disposable income continues to be a partial offset to the drawdowns in excess savings coming from above-trend growth in consumption spending and interest payments.

Underlying Consumption Growth Remains Solid

As is the case with headline inflation, headline real consumption spending growth often is driven by volatile components that not always reflect the underlying strength of the economy. A core real consumption spending growth measure, therefore, would be really useful, and I do that by approximating such a core measure based on the weighted median across 177 components¹ of headline real personal consumption expenditures (PCE). More specifically, the core, or underlying, consumption growth measure equals the growth rate of the real PCE component at the 50% percentile across growth rates of these 177 sub-components of headline real PCE.

The chart above focuses on three-month annualized consumption growth rates. The benchmark revisions affected the underlying (median) consumption growth rate the most in 2022, resulting in a significant upward revision in the path of underlying consumption growth, particularly in H1 2022 (blue vs. gray lines, chart above). This is one of the reasons why my estimate of excess savings discussed above was revised down (as well as a higher trend savings rate). More recently, the benchmark revisions affect the underlying consumption growth rates a lot less and mainly entailed some downward revisions in 2023.

Focusing on the most recent data, headline consumption growth overshot the underlying rate since Q1 2024 and this acceleration away from the median consumption growth pace continued in August. This means that we should expect a really strong consumption growth estimate for Q3. However, we should also expect headline consumption growth to cool beyond Q3 as the chart above indicates that headline consumption tends to realign with the median pace when large discrepancies between the two arise.

So, in Q3 headline consumption remained above trend although spending likely will ease somewhat in the coming months. But a large downshift in consumption is not expected over the next six months, as households are supported by strong wage income growth rates and still have healthy balance sheets and unspent accumulated excess pandemic savings.

Underlying Inflation Rates Close to 2% in Near-Term

In terms of inflation, core PCE inflation slowed in August to about an 1.6% annualized monthly rate from 1.9% in July (downwardly revised from 2%). Core goods inflation was negative again at -2.1% annualized month/month, down from -1.3% in July (upwardly revised from -1.4%), whereas core service inflation eased to 2.8% annualized month/month in August from a downwardly revised 3% in the preceding month.

The Fed’s favorite gauge of underlying inflation, core services excl. housing PCE inflation, also showed a slower pace from (a downwardly revised) 2.4% annualized month/month in July to about 1.9%. Given the large volatility in this measure since the pandemic it seems worthwhile to smooth through noisy month-over-month dynamics.

The chart above plots three-, six- and 12-month annualized inflation rates for the non-housing core services PCE deflator. The average annualized monthly rate still reads about 4% for the post-COVID era (black dashed line), two times the average rate we observed for the immediate years pre-COVID.

The momentum measures in the chart above have been sticky around 4% for most of 2023. In Q4 2023 momentum in core services excl. housing PCE inflation appeared to ease but this disinflationary trend reversed in Q1 2024. Since April, momentum in this non-housing core services inflation measure slowed again and this slowing became more pronounced over the past couple of months. Do note, however, that upward revisions in the current data vintage to inflation rates earlier this year means that in the chart above three- and six-month average growth rates now appears to have bottomed. Something to keep an eye for the remainder of the year

Instead of focusing on whether specific components of inflation should be ignored or not when assessing underlying inflation trends, one could focus on the central tendency of consumer price inflation, a.k.a. the center of the distribution of all price changes unaffected by extremely volatile consumer price components. This could potentially provide a better sense of the target toward which inflation moves over time once those excessively volatile price changes have stabilized.

Such measures of central tendency for the PCE price indices use a variety of trimming procedures to weed out excessive volatile components of these price indices in a given month²:

1. Median CPI, which takes the inflation rate of the component at the 50% percentile of the CPI component price changes.

2. Trimmed Mean PCE (Dallas Fed), where the highest 31% and lowest 24% of PCE component price changes are dropped.

3. 15% Trimmed Mean PCE, where the highest 7.5% and lowest 7.5% of PCE component price changes are dropped.

4. 20% Trimmed Mean PCE, where the highest 10% and lowest 10% of PCE component price changes are dropped.

5. 30% Trimmed Mean PCE, where the highest 15% and lowest 15% of PCE component price changes are dropped.

To get a sense of near-term trends in underlying PCE inflation I look at six-month averages of the annualized percentage point deviation of the above monthly central tendency inflation measures relative to their values as implied by 2% core PCE inflation. This is also consistent with public statements by Fed officials that they’d like to see sustained progress of inflation converging back to target, as measured over months and quarters of inflation progress.

The chart above suggests a qualitatively similar story as for the three-month average measures: a lot of progress was made by the end 2023 in terms of a return back towards the Fed’s 2% inflation target, in early 2024 this progress stalled but then returned later on.

The six-month average deviations of underlying PCE inflation rates relative to the inflation target in the chart above have declined notably over the last couple of months and are now suggesting an underlying PCE inflation trend of around 2.2%. So, over the near-term, the different central tendency inflation measures are signaling good progress in terms of an eventual return of core PCE inflation towards the Fed’s inflation target.

Over a somewhat longer horizon the underlying trends still remain above the 2% inflation target. The 12-month average deviations of underlying PCE inflation rates relative to the inflation target in the chart above still remain around 2.6% in August, signaling that a potential return to target will likely not happen until well into 2025.

From the perspective of the Fed underlying inflation rates have shown enough progress that for Fed officials to be comfortable cutting policy rates, as a number of Fed officials recently confirmed in their public remarks. However, given still strong underlying spending growth and a pace of wage income growth out-of-whack with the pace consistent with the inflation target the Fed will pursue a gradual policy rate easing path aimed at dialing down the restrictiveness of its policy stance closer towards neutral. This plus the Fed’s internal uncertainty about the appropriate neutral level of its policy rate could very well mean that we could see moderate rate cuts up to the March FOMC meeting followed by a pause in the easing cycle.

1. For a description of these 177 components, see Appendix A in the Dallas Fed trimmed mean PCE inflation working paper, where I use the corresponding real quantities instead of the price indices.

2. The trimming is based on the inflation rates of 177 components of the PCE deflator, see Appendix A in the Dallas Fed trimmed mean PCE inflation working paper,