Steady Wage Growth and Wealth Effects Support U.S. Consumer Spending

Steady Progress: U.S. Core PCE Inflation Trends and Consumer Spending Dynamics

by Faruk Imamovic
Steady Wage Growth and Wealth Effects Support U.S. Consumer Spending
© Getty Images/Justin Sullivan

In April, the U.S. core Personal Consumption Expenditures (PCE) inflation showed a modest increase of 0.25% month-over-month (MoM), aligning with earlier predictions from core Consumer Price Index (CPI) and core Producer Price Index (PPI) data. This update supports a continued narrative of gradual disinflation in the U.S. economy, albeit with specific areas of concern and potential risk. Our forecast for the fourth quarter of 2024 (4Q24) remains at a year-over-year (YoY) core PCE inflation rate of 2.9%, slightly adjusted from a previous estimate of 2.5%. This forecast underscores a slow but steady decline in inflationary pressures, heavily influenced by trends in the housing sector.

Dissecting April’s Core PCE Price Index

The core PCE price index provides crucial insights into the underlying inflation trends, stripping out volatile food and energy prices to offer a clearer view of persistent inflation. In April, core goods prices edged up by 0.1% MoM, marking the third consecutive month of increases. This trend suggests that the core goods sector, which had previously bottomed out, is now gaining strength. The three-month average for core goods prices reached its highest level since May 2023, indicating a potential upside risk to the broader inflation outlook.

A significant driver behind this rise is the recent surge in freight rates, alongside an uptick in wholesale prices for used cars in May—the first increase since September of the previous year. These factors point towards a more challenging inflation environment for core goods in the coming months.

Housing and Services: Key Influencers

Housing costs, another critical component of the core PCE, increased by 0.41% MoM, mirroring trends observed in the CPI data. After a period of stalling over the past six months, housing-related inflation has resumed its disinflationary trajectory. However, there are still reasons to be cautious. Private sector rent measures have stabilized recently, reflecting steady prices in both single-family and multi-family housing units. Our baseline expectation is for a gradual deceleration in housing cost increases to around 0.3% MoM later this year.

Core services excluding housing rose by 0.27% MoM, slowing from March. Notably, financial services—particularly portfolio management and investment advice—showed significant strength. Conversely, transportation services provided some relief, primarily due to lower air transportation costs. Health care inflation also remained subdued, increasing by just 0.08% MoM for the third consecutive month. This component has exhibited volatility in recent years and typically lags behind its PPI counterpart, suggesting a potential near-term increase.

Housing Costs Help Keep Inflation Running Hot
Housing Costs Help Keep Inflation Running Hot© Getty Images/Spencer Platt

Consumer Spending Amidst Soft Data

Despite soft data, U.S. consumer spending appears resilient. In April, real personal consumption slightly contracted by 0.1% MoM, following a robust March performance. This minor contraction is likely to impact second-quarter (2Q) real GDP estimates, with the Federal Reserve Bank of Atlanta revising its forecast down to 2.7% from 3.5%.

Real disposable income also fell by 0.1% MoM, continuing its recent downward trend due to higher inflation and increased tax payments. However, the overall trend in real wages and salaries has remained firmer. Despite the slight decline in April, consumers are expected to continue being a steady source of economic growth. Positive real wage growth, strong job creation, and robust population growth are key factors supporting this outlook. Additionally, wealth effects from rising house prices and stock market gains could further bolster consumer spending.

Real Goods and Services Consumption

April saw a 0.4% MoM decline in real goods consumption, driven by weaknesses in sectors such as information processing equipment and sports and recreational vehicles. Despite this, over the past year, information processing equipment and prescription drugs have been significant contributors to real goods consumption growth.

Real services spending showed modest growth at 0.1% MoM, with health care emerging as a strong sector. However, transportation services and net foreign travel were areas of weakness. This trend may reverse in May, as Transportation Security Administration (TSA) passenger volume data indicated a 6.8% YoY increase in 2023, suggesting a potential rebound in travel-related spending.

Solid Income Growth to Sustain Consumer Spending

Despite softer data for April, the outlook for consumer spending remains positive due to several supportive factors:

  • Real Wage Growth: Over the past 15 months, real wage growth has been solid, outpacing inflation. Average hourly earnings have risen significantly in 2023 and 2024, following a period of stagnation in 2020 through 2022.
  • Real Disposable Income: Although recent figures have been weighed down by higher taxes and firm inflation, these headwinds are expected to ease, supporting stronger growth in real disposable income.
  • Population Growth: Robust population growth, driven by strong net immigration projections, is expected to support consumption. The Congressional Budget Office (CBO) anticipates continued strong immigration over the coming year.
  • Wealth Effects: Significant gains in the stock market and rising house prices are contributing to wealth effects that support consumer spending. The S&P 500 has increased by over 25% year-to-date, and the S&P Case-Shiller Index reported a 6.5% YoY rise in house prices through March.
  • Debt and Credit Developments: Recent reports from the Federal Reserve Bank of New York (FRBNY) on household debt and credit have shown encouraging signs, suggesting a stabilization in the rate of deterioration in loans as of the first quarter of 2024 (1Q24).

As these factors converge, the resilience of the U.S. consumer is likely to remain a key pillar of economic growth, even amid ongoing inflationary pressures and economic uncertainties.