Personal Consumption Expenditures: Slowing spending, cooling inflation

Consumer spending fell 0.2% in December, as shoppers spent less on goods, even as they spent more on services, according to the Personal Consumption Expenditures data report issued Friday.

There are signs that the fall may be driven by inflation. A primary of the goods decrease was gasoline, where prices are coming down. Housing, where inflation is going up, was a driver of the increase in services. Yet the decreases in goods were “widespread,” the U.S. Bureau of Economic Indicators noted.

The PCE’s measure of Inflation increased 0.1% from November, marking the second straight month of slower growth after months of higher prices.

The annual inflation increase also slowed to 5%, down from 5.5% the month prior. PCE inflation, which is the pricing measure preferred by the Fed, is continuing to fall in a similar fashion to the more widely-used Consumer Price Index.

Core inflation, which is the inflation measure that leaves out the more volatile food and energy categories , slowed to 4.4%. That was its lowest level since October 2021.

The report offers a textbook look at how the Federal Reserve’s monthslong campaign to hike interest rates are playing out across the economy. The Fed’s main goal is to cool inflation, and prices are coming down. However, the Fed’s monetary policy tools also have the side effect of cooling demand, which leads to a decrease in consumer spending that is also evident.

The report comes days before the Fed will consider a further interest rate hike next week. Officials have signaled that they will continue the increases to fight inflation, but will consider whether to keep scaling back the size of the rate hike. The 0.5% increase in December was smaller than the 0.75% increases delivered at the four prior meetings.

The pullback in consumer spending was also evident among consumer goods companies that issued earnings reports this week.

3M, which makes Post-it notes, said organic sales fell 5.7% for the year.

“The slower-than-expected growth was due to rapid declines in consumer-facing markets, such as consumer electronics and retail, a dynamic that accelerated in December, as consumers sharply cut discretionary spending and retailers adjusted inventory levels,” said CEO Mike Roman.

GDP: Second straight quarter of growth

U.S. GDP: 2019-2022 (US Bureau of Economic Analysis)

The Fed’s moves bring with them the risk that the economy could tip into recession if demand cools off too much. Yet the overall economic data for the fourth quarter signaled to the positive.

Gross domestic product , which is a broad-based measure of economic activity, rose 2.9% in Q4 from the prior quarter, the BEA reported on Thursday.

Consumer spending, which is about two-thirds of GDP, was a key driver of the increase, as it rose 2.1%. Notably, spending on goods was up by 1.1% in the holiday quarter after three straight quarters of decline.

“We continue to see consumption as having tailwinds from tight labor markets, high levels of excess saving, and falling gasoline prices, among other factors,” Bank of America Economist Michael Gapen wrote in a research note.

The report also points at another trend of 2022: People returned to spending on experiences and services as pandemic restrictions were lifted. However, that may be cycling out. The increase in goods spending and a corresponding slowdown in services “suggests the rotation of household spending back toward services may be nearing its end, though we hesitate to say it is completed,” Gapen wrote.

It marked a second straight quarter of economic growth to end 2022, showing that the economy turned around from two straight quarters of decline to begin the year.

Inflation also cooled for the quarter. The PCE Price Index rose 3.2% for the quarter, compared with an increase of 4.3% in the third quarter.

Consumer sentiment: Improving for the second straight month

U.S. consumer sentiment, 2013-2023

U.S. consumer sentiment rose 9% in January from the prior month, continuing a climb of the doldrums that reached historic lows at inflation’s height over the summer, according to the University of Michigan .

In particular, consumers’ view of current economic conditions rose 15%. With strong incomes in a tight job market and falling prices as inflation cools, people feel better about their finances and would be more likely to make bigger purchases, UM wrote.

People are also looking for inflation to continue to cool. The year-ahead inflation expectation of 3.9% was the lowest level since April 2021. Yet declines should be viewed as “tentative,” since uncertainty remains, UM said.

While sentiment is improving, it is still at historic lows. Economic volatility remains, so the good signals shouldn’t necessarily be interpreted as outright optimism.

“There are considerable downside risks to sentiment, with two-thirds of consumers expecting an economic downturn during the next year,” wrote University of Michigan Survey of Consumers Director Joanne Hsu. “Notably, the debt ceiling debate looms ahead and could reverse the gains seen over the last several months.”