Personal disposable income jumped 0.5% after adjusting for inflation in March. That follows downward revisions for the previous two months. The March increase in incomes occurred despite weaker employment and wage growth for the month. Much of the increase came from a jump in social security payments, something that will become a larger factor as more baby boomers move into their retirement years.
Personal consumption expenditures rose 0.3% after adjusting for inflation but followed downward revisions to January and February. Moreover, all of the increase in spending may be attributed to a rebound in spending on utilities when temperatures plummeted after an unusually warm winter. Spending outside of utilities was weak. Much of that weakness, however, is transitory and already showing signs of a rebound during the second quarter.
Perhaps most importantly for those watching the Federal Reserve and what might be decided this week: Both the overall and core measures of the PCE inflation index dropped. This is the Fed’s favored measure of inflation. The overall PCE index fell 0.2% while the core measure dropped 0.1%. Some of the weakness in inflation was expected, given the lower energy prices and the deep discounting of winter clothing that resulted from the mild winter.
The surprise showed up in a slower pace for services inflation, which Fed officials expected to move up, not down, in response to wage pressure.
We see three reasons for the drop in services inflation:
- Accommodation prices fell as snow storms across the Midwest and East Coast caused thousands of flights to be cancelled. Hotel rooms that had been booked were then unloaded at deep discounts that appeared instantaneously via the apps now available on our phones. Foreign tourism, which had supported the luxury hotel market, has fallen in response to tighter border rules.
- Cell phone service providers became more competitive and offered deep discounts.
- Sporting events (with the exception of Chicago Cubs games) also became cheaper, which suggests that we may be seeing a shift in how corporations and individuals are spending their entertainment dollars.
On net, overall PCE inflation slowed from a 2.1% to a 1.8% annual pace between February and March. The core PCE decelerated from a 1.8% to a 1.6% pace.
It is too soon for the Federal Reserve to back off the expected two more rate hikes this year. The May meeting is already off the table for a rate rise. The pause in inflation could delay the next rate increase from June to later in the summer. The larger issue will be how it affects the plans to shrink the Fed’s balance sheet. There is a push to have some kind of announcement on how the balance sheet might be downsized before Chair Janet Yellen’s tenure expires in early 2018. It is unclear, however, if the process of tapering can begin in 2017.
Separately, the construction data released today was also weak in March. However, large upward revisions to January and February offset that weakness. The result is that the first quarter estimate of 0.7% holds.
Data on the second quarter is solid so far but spectacular. The Purchasing Managers’ Index came in with market expectations for April, as manufacturing activity rose but at a slightly slower pace than March. The Institute for Supply Management (ISM) index was more of a disappointment but continued to show growth. The vehicle sector is cooling as the mining sector picks up. Employment was up, but at a slower pace than in March. That is consistent with our forecast for anothermonth of moderate employment gains in April. The anecdotal reports suggest that heightened geopolitical uncertainty could be a problem for businesses. Defense looks like it was on an upswing, even prior to the small increase we saw in the federal budget approved for the next six months last night.
Bottom Line: The first quarter was messy and filled with glitches. Growth is on track to bounce back in the second quarter. Weaker than expected inflation data, coupled with expectations for a slight disappointment in the employment report on Friday will likely cause the Fed to delay hiking rates for a bit. The Fed will have to acknowledge the weakness in inflation, which means we may see a more dovish statement following the Fed’s meeting this week.