The PCE price index, which the Fed uses for its inflation target, rose 0.6% month-on-month and 6.4% compared to February 2021, reaching its highest level since 1982. Spending not adjusted for inflation rose 0.2% from January, while revenues rose 0.5%. Purchases of goods and services, adjusted for changes in prices, decreased by 0.4% month-on-month after increasing by 2.1% in January. This shows that the fastest rate of price increase in forty years has softened demand. Geopolitical developments and uncertainties about the economic trajectory may put more pressure on discretionary spending in the coming months and slow the momentum on growth.
If we look at the sub-items; After increasing 5.6% in January, goods expenditures adjusted for inflation decreased by 2.1% compared to the previous month. Spending on services rose 0.6% to a seven-month high. The core PCE price index, which excludes food and energy and is generally seen as a more reliable guide to underlying inflation, was up 0.4% month-on-month and 5.4% higher than a year ago.
After omicron-related volatility in the previous two months, data shows American consumers are in the grip of the fastest inflation in decades. The continued strength in the labor market – combined with excessive savings – has provided many households with resources to continue their spending. Yet rapid inflation eroded wage growth and increased the costs of necessities such as energy, food and rent. The data largely reflects the inflationary environment before the start of Russia's war in Ukraine, which drove prices higher. Rapid inflation in the US economy has left households with less cash to spend on on-demand goods and services such as dining out. Inflation eroded most of the increase, although wages and salaries rose the most in four months. The savings rate has returned to pre-pandemic levels. A further decrease in the ratio indicates that consumers were spending on savings from various financial incentives during the crisis. Inflation-related income growth will deter price-sensitive consumers from spending at this fast pace going forward. For this reason, it is important that wages and naturally real incomes have a positive trend, but this will also bring inflation.
Comparison of US PCE inflation and real expenditures… The increasing momentum in price increases causes signs of softening in demand. Source: Bloomberg
The acceleration in inflation raises concerns about the breadth and persistence of price pressures and supports the Fed's calls for more aggressive rate hikes. The Fed will have to balance the fight against even higher inflation as the risks of a slowdown in consumption amid rising prices and heightened uncertainty. The fact that the Russian embargo will most likely not be lifted anytime soon also complicates the inflation situation. A possible robust March jobs report, released tomorrow following the latest price data, could bolster the Fed's expectations for a half-point hike in May's benchmark rate. As Powell recently noted, the FOMC is no longer comfortable with the volatility of inflation: “As the world finally adjusts to a new normal, the hoped-for supply-side recovery remains likely to come over time, but the timing and extent of this relief is highly uncertain. Meanwhile, for policy; We will be looking for real progress on these issues and we will not expect any significant relief on the supply side in the short term”.
Increasing geopolitical uncertainty will fuel concerns about rising energy prices, persistent supply constraints and a hawkish Fed. The hawkish stance adopted by the Fed is supported. On the other hand, the Ukraine war has exacerbated existing concerns about the impact of rising prices, supply chains, and reduced fiscal and monetary stimulus. The statements of Fed speakers since the FOMC meeting in March have confirmed one thing: The FOMC would have increased interest rates by 50 basis points in March if Russia had not invaded Ukraine. The war immediately fueled inflation. Fed hawks will further harden their resolve and call for more 50 basis point rate hikes. Market participants expect a funding rate of close to 3% for 2023, which may support the phenomenon of the Fed moving faster to the terminal rate.
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