June 27, 2024
Personal income declined 0.4% in May while consumer spending fell 0.1%. On the surface it appears that, at long last, the consumer is beginning to curtail his or her pace of spending. But that would be a mistake. Both numbers are seriously distorted. The decline in income was caused by a drop in Social Security payments associated with the Social Security Fairness Act passed in January. The decline in spending in May was caused entirely by a drop in motor vehicle spending. But two months earlier such spending surged as consumers purchased new cars prior to the implementation of tariffs in early April. That resulted in a huge increase in spending on autos in March and a corresponding drop in May. Tariffs have distorted the normal patterns of growth for virtually every economic indicator in the first five months of this year. Following the 0.5% decline in GDP in the first quarter, we expect GDP growth of 3.5% in the second quarter. Growth for both quarters was impacted by swings in imports and, to a lesser degree, inventories. Final sales to domestic purchasers omits both of these volatile categories and, presumably, provides a better read on what is actually happening to the economy. After increasing 1.5% in the first quarter we expect domestic sales to increase 2.5% in the second quarter. It continues to be challenging to get a clean read on the pace of economic activity. But despite the imposition of tariffs in April and the subsequent changes, the outbreak of war between Israel and Iran and the U.S. bombing of Iran, the economy continues to display remarkable resilience.
Personal income declined 0.4% in May. But the wage component gained 0.4% for the month and wages have risen 4.9% in the past year. This reflects steady growth in both employment and hourly earnings which should continue to climb in the months ahead.
The decline in income in May was caused by transfer payments which declined 2.2% led by a sharp drop in Social Security payments. This is normally a category that increases slowly but steadily every month. The Bureau of Economic Analysis indicated that the drop was associated with the Social Security Fairness Act passed back in January. Provisions in that bill reduced or eliminated the Social Security benefits of more than 2.8 million people who received a pension based on work that was not covered by Social Security taxes. As a result, those individuals found their monthly benefits reduced. But this is a one-time drop in Social Security benefits which should once again grow steadily in the months ahead.
Perhaps more important is the growth of real disposable income which is after tax income adjusted for inflation. In the past year this category has risen 1.7%. This income provides the fuel for consumer spending. If real disposable income climbs by 1.7%, consumer spending can do the same and the consumer will not have to borrow to sustain that pace of spending.
Real consumer spending declined 0.3% in May. But that follows a 0.7% increase in March and a 0.2% increase in April. These monthly changes reflect an accelerated pace of spending in March as consumers rushed to buy new cars ahead of the imposition of tariffs in early April. It was also the cause of the 0.3% decline in May. Looking at the May drop in isolation appears disquieting. But combining the big increase in March with the May decline suggests that the pace of consumer spending has not slowed appreciably. In the past year real consumer spending has risen 2.2%. As noted above, real disposable income is climbing at a 1.7% pace. We expect that consumer spending will rise at a sustainable 1.3% pace in 2022. When combined with an expected 5.5% growth rate for nonresidential investment (led by rapid spending on AI stimulated growth in computer hardware and software). we end up with our projected GDP growth for the year of 2.0%. As nearly as we can tell, our projected growth rate of 2.0% compares to a consensus forecast for GDP growth of roughly 1.0% in 2025.
We also learned this past week that the core personal consumption expenditures deflator increased 0.2% in May and has now risen 2.7% in the past year. We expect the PCE deflator to also rise 2.7% in 2025. This is the inflation measure that the Fed would like to increase by 2.0%. That is not going to happen any time soon.
The Fed thinks the economy’s potential growth rate (its non-inflationary speed limit) is 1.8%. We expect GDP growth of 2.0% for the year. The Fed thinks full employment is achieved when the unemployment rate is 4.2%. We expect that rate to be 4.3% at the end of the year. The Fed wants the core personal consumption expenditures to increase 2.0%. We expect it to climb by 2.7%. But forecasts are forecasts. They might be reasonably accurate, but they may not. If we are correct it is hard to see how the Fed will be able to cut rates twice in the second half of this year which is what both it and the markets expect to happen. At the moment the Fed’s thinking is split with about one-half of the FOMC members expecting two rate cuts by yearend and the other half anticipating no change. We will put our money on the no change group.
Stephen Slifer
NumberNomics
Charleston, S.C.
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