Fed’s Preferred Gauge Of Inflation Rises Again: Fed’s Plan in Jeopardy?

The article “Fed’s Preferred Gauge Of Inflation Rises Again – Is Fed’s Plan in Jeopardy?” analyzes the Personal Income and Outlays data for January 2023, which is the Federal Reserve’s preferred gauge of inflation, & highlights the worrying results that could potentially jeopardize the central bank’s plan to pull down inflation & revive the economy. The article also discusses the increase in consumer spending, PCE prices, & inflation expectation, posing a challenge to the Federal Reserve’s efforts to tame inflation. The article suggests that the coming months will be a bumpy road for policymakers, especially the Federal Reserve, to cool the economy & combat inflation.

Introduction

On 24^th February 2023, Personal Income and Outlays for January 2023 were released by the Bureau of Economic Analysis (BEA). This is the Federal Reserve’s preferred Gauge of Inflation, and the result of January 2023, is not as per the Federal Plan! 

Till December the overheated economy was slowly cooling, consumer are withholding their consumption and inflation was slowing down – all these were happening according to Federal Reserve’s plan. 

Federal Reserve’s Plan to pull inflation down and put the economy back on a growth path is now in trouble. The reason is the data released on Friday is worrying.

Why it is so? Let us now see the summary of the Data and try to understand it:

Personal Income

According to Estimates released by BEA, in January 2023, personal income increased by 0.6% at a monthly rate (that is $131.1 billion). 

Disposable Income (DI) is increased by 2.0% (that is $387.4 billion). Personal Savings Rate (as a percentage of personal disposable income) was 4.7% in January 2023, compared to 4.5% in December 2022.

In January 2023, Personal outlays increased to $326.8 billion. This is mainly driven by consumer spending for both goods and services. S 

Source: U.S. Bureau of Economic Analysis (BEA)

Consumer Spending

Consumer spending has increased by 1.8% (which is $ 312.5 billion). This increase is mainly driven by an increase in compensation. 

The government decreased social benefits in January, and the decrease in other benefits was balanced by the increase in Social Security. This increase in Social security is reflected in the cost-of-living adjustment which is at 8.7%. 

PCE Prices

Personal consumption expenditures (PCE) increased by 1.8% (which is $312.5 billion). In January 2023, the PCE price index increased by 0.6%. 

On Year on Year basis

Federal Reserve’s Favourite Inflation, the Personal Consumption Expenditure (PCE) price index for January increased by 5.4%, compared to last year. This reflects the increase in inflation of both goods and services. Food Prices increased by 11.1%. Energy prices increased by 9.6%. 

The Core PCE price Index (i.e. excluding food and energy) has increased by 4.7% compared to the corresponding period last year. 

Real disposable personal income and consumer spending:

The Real DPI and Real PCE have increased by 1.4 % & 1.1% respectively. The Goods and Services have increased by 2.2% and 0.6% respectively. 

The increase in motor vehicles and parts along with recreational goods was somewhat balanced by a decrease in Gasoline, in the Goods. Whereas in Services, the increase in accommodations and food services was relatively balanced by a decrease in housing and utility (mainly utilities). 

These are the summary of the BEA Personal income and outlay data. 

Bumpy road ahead

The Data released on Friday is evident that consumer spending is increasing on goods and services, especially services like restaurant meals, and vacation travel. The January employment data has shown that the economy has added half a million jobs and wages continue to rise. 

Many questioned Federal officials about their policy stance on inflation last year. However, the present data is showing a bumpy road for the Federal Reserve. This seems that there is still more to do for the Central bank to bring inflation down. 

The slowdown is more gradual but not as steady as expected earlier. In November and December, Personal Spending fell slightly, but in January it hopped to 1.8% faster than Inflation. An increase in income will support the strong increase in spending in the coming months. 

On Friday, President Biden said in his statement on January PCE Report that 

“Today’s report shows we have made progress on inflation, but we have more work to do. Annual inflation in January is down from the summer, while the unemployment rate has remained at or near a 50-year low and take-home pay has gone up.”

The Federal’s interest rates range, as many forecasters expect, may be higher than 5-5.25% as expected earlier. Whatsoever, the Coming months it’s going to be a clear bumpy road for the Policymakers (esp. Federal Reserve) to cool the economy and particularly to fight inflation.

Federal Reserve’s Fight against Inflation 

Since the 1980s, Federal Reserve has raised the interest rate at the fastest pace ever from near zero to more than 4.5%. This increase in interest rate is done with the objective to slow down consumer demand and also to bring inflation down. 

Fed Chair Jerome Powell, earlier in February, warned that it takes a “significant period of time” to fight inflation and that the Central bank would likely keep interest rates higher for a longer period. 

It is pertinent to remember and understand that, in the USA, the monetary policy does not act on a lag – the rapid increase in interest rates has gone down in some areas already. This is visible in financing and housing. 

As the ongoing labour shortages will keep upward pressure on wages – this is the biggest hurdle for Fed’s effort to tame inflation is harder. 

Another most worrying factor or say challenge for the Federal Reserve is inflation expectation. The inflation expectation has bounced back to 4.1% this month. This is an increase from 3.9% in January and down from 4.4% in December 2022. However long-run expectations held at 2.9% for the third month in a row, according to the report.

For the Federal Reserve, this is a very important data point. It is because if the consumer believes that prices will remain high then there will be increased wage demands which would result in raise in prices by the business. If Inflation expectations are high then it would be very difficult for the Federal Reserve to tame inflation. 

What would be Federal Reserve’s Response?

Now, as the Fed’s preferred inflation Gauge – PCE has increased, which means there is another hike in coming months. Irrespective of what other data shows, the Federal will go for another hike. There are still risks of recession arond the corner.

As the Fed is concentrating more on PCE and Super Core Inflation and if the result of these Inflations has not come down then Federal Reserve may get more aggressive. If Fed becomes more aggressive then there is more chance that may lead to a Recession. It is pertinent to watch how Federal Reserve is going to response on these data points and whether US will avoid recession. We need to wait and watch.

Conclusion

The data released by the Bureau of Economic Analysis (BEA) on January’s personal income & outlays has put the Federal Reserve’s inflation plan in jeopardy. The increase in personal income, disposable income, & consumer spending on goods and services, along with an increase in compensation & social security, has led to an increase in inflation. The PCE price index for January increased by 5.4%, reflecting an increase in inflation of both goods and services. The Federal Reserve’s fight against inflation seems to be a bumpy road ahead as labor shortages keep upward pressure on wages & inflation expectations bounce back. Policymakers, especially the Federal Reserve, have a challenging task ahead to cool the economy and fight inflation in the coming months. It remains to be seen how the Fed will tackle this issue and whether the interest rate will be raised higher than the expected 5-5.25%.

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