Jan Personal Income & Outlays: Coming Off the Boil?
Personal wage income and underlying real spending slowed but remain firm. Underlying services inflation trends rebounded.
The January Personal Income and Outlays report provide 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 slowed down in January but still outpaces the growth rate that is 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 December and January, it fell around $37 billion and equaled about $561 billion in January.
Real PCE growth eased, with the underlying (trimmed mean) growth rate similarly slowing while still outpacing the headline rate in January. This suggests that consumption will remain firm in H1 2024 but less so than in H2 2023.
Core services excl. housing PCE inflation, the Fed’s favorite gauge of underlying inflation, remains at elevated levels on a year/year basis and re-accelerated.
Despite slowing momentum in real spending, still solid growth rates of wage income and spending as well as re-accelerating non-housing core services inflation will mean the Fed remains wary of starting to cut rates too early in 2024.
Wage Income Growth Remains Strong.
A dominant source of household income is personal income out of wages and salaries. Today’s report showed essentially some upward revisions in the recent growth of household income out of wages and salaries throughout H2 2023.
Compared to the vintage from last month’s report, the pace of year/year income growth out of wages and salaries for August-December was revised up (chart above). For the first time since September the year/year growth rate decelerated in January, to 5.4% from 6.9% (revised up from 6.5%) in December, possibly reflecting the sharp (weather related) slowdown in hours worked in January. Note that overall personal income growth was essentially unchanged at 4.8% year/year, implying that growth of non-wage income (interest and dividend income as well as government transfers) picked up in January.
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 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 the 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 momentum in the wage income growth gap based on the Fed’s inflation target slowed down to about +1.1-percentage point, and the three-month averaged version still runs at about a +2-percentage points gap. Hence, despite slowing somewhat nominal wage income growth continues to run at a pace that remains too high to be able to bring inflation back to target in the medium term.
Earlier I showed that the common trend across near-term inflation expectations of firms and households has eased towards the end of 2023 and currently sits at a year/year PCE inflation equivalent rate of 2.6%. Given the growing gap between personal income out of wages and the medium-term benchmark consistent with 2% inflation, the personal wage income growth pace is also overshooting the medium-run pace that would be consistent with this 2.6% inflation expectation rate. Elevated wage income growth therefore remains an upside risk to the medium-term inflation outlook.
With household income growth out of wages and salaries still running above the pace consistent with 2% PCE inflation this might be a sign that households’ incomes are likely to remain strong enough to keep consumption spending elevated.
Excess Savings Are Declining Only Gradually
Household spending was up 0.3% over the month in January, a similar pace compared to disposable household income growth of 0.3% for the same period. As a consequence, the savings rate went up ever so slightly from 3.7% in December (unrevised) to 3.8% in January.
The chart above shows that the savings rate remains below my trend savings rate estimate of 5.7% (down from an upwardly revised 5.8% in December) using the ‘average of trend’ approach outlined in my earlier excess savings note (orange line). The actual savings rate had been diverging to the downside relative to this trend savings rate estimate since May, but a lot less so compared to trend savings rate assumptions used elsewhere (grey and yellow lines).
Given the earlier discussed revisions to both personal wage income growth and my estimate of the trend savings rate, in January cumulative excess savings declined from $598 billion in the previous month (upwardly revised from $593 billion) to about $561 billion (see chart above).
Compared to 2022 we’ve seen in 2023 and, so far, as well in 2024 that above-trend growth in disposable income partially offsets the drawdowns in excess savings coming from above-trend growth in consumption spending.
Trend Pace in Consumption Spending Slowed
Strong income growth out of wages in 2023 allowed households to keep spending at a robust pace without the need to completely run down the stock of excess savings. With wage income growth remaining above inflation target pace, this could mean that real consumption expenditures can be expected to remain relatively high for the near term.
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 constructing a weighted trimmed mean across 177 components1 of headline real personal consumption expenditures (PCE). This trimmed mean measure provides a more accurate reading on the underlying strength of the economy than headline real PCE growth rates, with the trimmed mean measure decreasing ahead of headline growth before the onset of a recession.
When we focus on the most recent period as in the chart above, the six-month annualized headline real PCE growth was basically in line with the trimmed mean six-month growth rate throughout 2022. That changed in 2023 trimmed mean real PCE growth outpacing headline growth, with the gap between the six-month annualized growth rate of trimmed mean real PCE and that of headline PCE increasing since October. In January, however, both the headline and trimmed mean growth rates decelerated but the trimmed mean measure remained above the headline growth rate.
The continued elevated pace of trimmed mean real PCE growth relative to the headline growth rate likely means that consumption will remain firm going in Q1 2024 and, possibly, Q2 2024, albeit less strong than in H2 2023.
Firming of Underlying Inflationary Pressures
In terms of inflation, core PCE inflation accelerated in January to a 5.1% annualized monthly rate from a (downwardly revised) 1.8% rate in December. Core goods inflation equaled -0.6 % annualized month/month (up from -3.3% in December), whereas core service inflation accelerated for the third consecutive month from 3.7% to about 7.1% annualized month/month in January.
The Fed’s favorite gauge of underlying inflation, core services excl. housing PCE inflation was a main driver behind the above-mentioned January core service inflation acceleration, as it went up for the third consecutive time from 3.1% annualized month/month to about 7.4%. This could very well be a reflection of adjustments to imputed prices for financial services (especially portfolio management services), as these align well with asset prices which have seen a strong recovery throughout November-January. Note though that weakness in these same asset prices over the summer and early fall could equally have responsible for the deceleration in non-housing core services inflation throughout that period. In any case 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. But in Q4 2023 momentum in core services excl. housing PCE inflation appeared to ease in a tentative sign that it might finally start to break free from the post-pandemic 4% trend. However, the January data at least partially reverses this disinflationary trend. Although temporary factors (such as residual seasonality and imputed portfolio management prices) *might* have some role to play in this, the recent data at the very least confirms that underlying inflation has become more volatile than in the pre-COVID era.
With households’ wage income growth still supportive of above-target PCE inflation over the medium term, a still strong labor market, sizeable stocks of excess savings, and underlying strength in real consumption spending, conditions continue to be in place that could slow down the disinflation in the core services sector. And with a more variable underlying core services inflation rate, it is clear the Fed will want to carefully assess the data before commencing a rate easing cycle. Fed funds rate cuts thus are likely not happening before mid-2024.
For a description of these 177 components, see Appendix A in the Dallas Fed trimmed mean PCE inflation working paper.