PCE February 2024: Personal Spending Too Hot For Fed Rate Cuts

The Bureau of Economic Analysis (BEA), has just released its estimate for February 2024 US Personal Consumption Expenditures (PCE). Also known as “Personal Spending,” PCE directly accounts for over 60% of total US Gross Domestic Product (GDP), marking it a crucial indicator for assessing changing rates of expansion, contraction, and momentum in US economic activity.

According to the BEA, Real PCE (adjusted for inflation) expanded by 0.43% — an upside surprise compared to the median forecast of professional economists which expected 0.33% growth.

The question now is: Based on a thorough analysis of the PCE data, and the initial market reactions to it, should investors make any adjustments to their economic forecasts, and/or to their investment strategies?

The right answer is never an obvious one. Success in investing largely depends on finding difficult-to-obtain information and/or insights that supply an informational and/or analytical edge. This requires both diligence and skill. Our method, focused on five key questions, helps us generate an edge from analyses of just-released economic reports:

1. Was there any surprise?

2. What caused the surprise?

3. Did the surprise alter the macroeconomic outlook?

4. Is anything in this report being misunderstood or overlooked?

5. Has the initial market reaction given rise to any actionable opportunities?

In this article, these questions will be addressed as we walk readers through a four-step process.. First, we will perform a comprehensive analysis of the just-released report. Second, we will update macroeconomic forecasts, based on this analysis. Third, we will adjust our investment assessments of major asset classes. Finally, we will deliver actionable insights that will enable readers to capitalize on our analysis.

Headline Data And Initial Market Reactions

We begin our analysis with a review of headline data that is summarized in Figure 1. We recommend that readers make note of the percentile rank of the rate of change (growth or contraction), and sequential momentum (acceleration or deceleration). Most importantly, readers should identify any surprises (i.e. deviations from forecasted values), as these tend to drive the initial reactions in the market.

Figure 1: Change, Acceleration, Expectations, and Surprise

Current dollar PCE surprised to the upside. As can be seen in Figure 1, the nominal dollar value of PCE (not adjusted for inflation) for February 2024 totaled $19,189.04 billion at a monthly annualized rate, a new all-time record. The 0.76% MoM rate of change was above the historical median, ranking in the 71st percentile. Relative to the median estimate of professional economists of 0.50% growth, this month’s PCE represented an upside surprise of 0.26%.

PCEPI inflation surprised to the downside. The PCE Price Index (PCEPI), a measure of consumer prices which is closely followed by the US Fed, indicated inflation of 0.33% during February 2024, decelerating by -0.04% compared to the inflation of 0.38% in January 2024. The PCEPI inflation in February represented a downside surprise of -0.07% compared to the median estimate of professional economists of 0.40%. Core PCEPI was reported at 0.30% which was in line with the median estimate.

Real PCE surprised to the upside. By combining both of the factors above – the current dollar value of personal spending adjusted by consumer price inflation – we can see that Real PCE totaled $15,688.69 billion (at a monthly annualized rate). This month’s rate of change of Real PCE (0.43%) was above the historical median rate of change, ranking in the 82nd percentile. Relative to the 0.10% growth expected by the median forecast of professional economists, the reported MoM change surprised to the upside by 0.33%.

A Deep Dive Into The BEA’S PCE Data

In this section of our report we will walk our readers through a comprehensive analysis of the latest PCE data. The analysis is broken down into three subsections: 1) Analysis of the impacts of inflation. 2) Rates of change and momentum of Real PCE components. 3). Attribution analysis. Our goal in this section is to pinpoint the specific causes of any deviations from forecasts (i.e. surprises) and to uncover anything which may have been misunderstood or overlooked by market participants.

Prices Matter: The Impact of Inflation and Deflation on Personal Consumption Expenditures

In this subsection, we highlight the impacts of price changes (inflation or deflation) on personal spending data. Any serious analysis of PCE must seriously consider this matter because price changes directly affect the quantity of goods and/or services that a given amount of money can purchase.

In Figure 2, we show Personal Consumption Expenditures in both “current dollars” and in “real” terms. The “real” figures adjust the nominal current dollar figures for the changes in purchasing power caused by inflation/(deflation). The purchasing power adjustments to the PCE consumer spending data are made by applying the appropriate PCE price indexes (PCEPI), that are published on the same day as the report on Personal Income and Outlays. It is important to note that the PCEPI is the US Federal Reserve’s favored consumer price inflation.

Figure 2: Personal Consumption Spending in Current Dollars and Adjusted for Inflation

As can be seen in Figure 2, personal spending in current dollars during February was estimated to have grown by 0.76% MoM. However, consumer prices, as measured by the PCE price index, “inflated” by 0.33% during the month. Real PCE, which adjusts the current dollar spending figures for inflation, is estimated to have expanded by 0.43% during the month of February. This is a very strong number which ranks in the 82nd percentile historically.

It is important to note any divergences between the Goods and Services categories. When analyzing changes in consumer prices and real personal spending.

Price divergences. Goods prices during February inflated by 0.49% MoM, compared to a 0.26% change in prices of services. Prices of services tend to be stickier than the prices of goods. Services prices, which have been a major problem, decelerated significantly and were below expectations. However, goods prices accelerated significantly. If goods prices, which are currently a drag on overall inflation, merely revert to normal levels of inflation (around +0.1% per month) before services prices do, then overall PCE inflation could become extremely high. This would be very problematic for interest rates and Fed policy and, ultimately, for economic growth.

The services PCEPI was notable in that it diverged significantly from Services CPI. We will have to see if the downward move reported this month services PCEPI persists and/or if the upward move in Goods PCEPI persists.

Spending divergences. Real personal spending on Goods (inflation-adjusted) in February was estimated to have expanded by 0.05%, compared to growth of 0.61% in real consumer expenditures on services.

Please note that for the remainder of this article, all Personal Consumption Expenditures (i.e. personal spending) figures will be presented in “real” (inflation adjusted) terms.

For the remainder of this article, all figures will be presented in “real” (inflation adjusted) terms.

Rates of Change and Momentum of Real PCE Components

In this subsection we present the major components of Real Personal Consumption Expenditures (PCE), scrutinizing their annualized growth rates over various time frames (1m, 3m, 6m and 12m). The purpose of this analysis is two-fold. Our first purpose is to identify the relative growth of various components of PCE compared to each other, and to the overall aggregates. Our second purpose is to determine whether, and to what extent, growth rates are accelerating or decelerating over various time frames.

We will mostly focus on the 3-month rate of change, which is generally the best indicator of current strength and trends. However, the 1-month, 6-month and 12-month data are important reference points.

Figure 3: Annualized Growth Rates of Major Components of Real PCE

Strength and momentum of overall growth. As can be seen in Figure 3, overall real spending growth, on a 3-month annualized basis (2.71%), remained above the historical median (61 percentile), with a strong rate of change data (82nd percentile) for the most recent month. It is also significant to note that the 3-month annualized growth rate of personal spending has decelerated substantially relative to the 6-month annualized growth rate of 3.25% (80th percentile).

Divergences in rates of change between categories. It is interesting to note that during the past 3 months the rate of change of consumer goods spending and consumer services spending has been very uneven. In the Goods sector, the 3-month annualized growth rate of spending (-2.02%) was very weak on a 3-month annualized basis (13th percentile), despite rebounding during the most recent month (40th percentile). By contrast, the annualized growth rate (+5.07%) in spending on Services during the past 3-month period was extremely strong (93rd percentile), in part due to strong growth during the most recent month (93rd percentile).

Economically sensitive consumer spending. Identifying any trends in economically sensitive consumer spending plays an important role in our macroeconomic forecasting as it can provide leading signals. Spending in the economically sensitive Durable Goods category grew at a 3-month annualized rate of (-0.09%) which is significantly below the historical median (25th percentile) despite the extremely strong showing in this past month (78th percentile).

Notable rates of change. It is interesting to pay attention to some specific PCE categories and periods in which the 3-month annualized rates of change of consumer spending have been notable (based on historical percent ranks). Items in which particularly notable positive rates of 3-month annualized growth have been registered include: 14.71% (100th percentile) in category Financial Services and Insurance and 18.42% (94th percentile) in category Transportation services. By contrast, items in which notable rates of contraction were registered include: -10.65% (8th percentile) in category Gasoline and other energy goods and -4.92% (8th percentile) in category Food services and accommodations.

Attribution Analysis: Change and Acceleration of Real PCE

In this subsection our analysis is focused on identifying the contributions that various categories make to the MoM Change and MoM Acceleration of Total PCE.

Figure 4: Contributions to Change and Acceleration Attributable to Major Components

As can be seen in Figure 4, the MoM rate of change in total real PCE in February (0.43%) accelerated by 0.65% compared to January (-0.22%). This momentum is attributable to a 0.44% contribution to acceleration in Goods and a 0.21% contribution to acceleration in services.

Within the goods category, Durables were particularly strong contributing +0.45% of the total acceleration while Nondurables contributed -0.01%.

Let’s drill down further and analyze the contributions of some more specific categories. This detailed analysis will generally help us greatly in trying to answer the question: What caused the surprises relative to forecasts? The starting point for the analysis is noting that the Month-on-Month rate of change momentum was +0.65%: The specific question that we are responding to in this subsection is: What specific categories caused the MoM rate of change to differ by this particular amount from one month to the next? The +0.65% momentum figure is a net figure that is generally the result of items that pushed the rate of change rate up, and items that pulled the rate of change down. What specific items made the largest contributions toward pushing the monthly rate of change momentum in an upward direction (acceleration), and which items pulled the rate of change momentum in a downward direction (deceleration)?

Items that accelerated notably, making positive (upward) contributions to overall momentum were: Motor vehicles and parts (+0.35%) and Food Services and accommodations (+0.10%).

Items that decelerated notably, and therefore pulled overall momentum in a negative (downward) direction, were: Housing and utilities (-0.08%) and Clothing and footwear (-0.06%).

US Economy Outlook: Implications of the PCE Data

In this section we address the following question: Based on our comprehensive analysis of the just-released PCE data, what (if any) changes should we make to our macroeconomic forecasts and/or our overall outlook for the US economy?

Updates to US Economic Forecasts

Let’s begin with a brief review of forecasters’ expectations leading into this report. The median forecast of professional economists expected the BEA to report that real personal spending grew at a rate of +0.10% percent during the most recent month (40th percentile). Assuming that this forecast had been completely correct, and that there were no revisions to prior data, the 3-month annualized change of Personal Spending would have been a +2.17% growth rate, ranking in the 34th percentile historically.

As it turns out, reported data (including the figures for the most recent month and revisions to prior months) indicate that PCE grew at a 3-month annualized rate of 2.71%, a rate of change which ranks in the 61st percentile historically. This is quite significant as the expectation has swung from below-average (34th percentile) spending growth to above-average spending growth (61st percentile).

The implications for forecasts and outlooks of various key macroeconomic conditions are as follows:

Business cycle risk. The above-average rate growth of Personal Spending (61st percentile) during the past three months indicates that the risk of a business cycle recession in the US, at any time during the next six months, is extremely low. However, because the US economy is in the Late Expansion stage it is more vulnerable to an exogenous shock than during other stages.

Economic Activity. As stated earlier, economic forecasters had been expecting today’s report to indicate a below-average growth rate of personal spending, on a 3-month annualized basis. As a result of today’s reported figures which delivered an upside net surprise (including revisions), forecasts of the growth rate of US economic activity will tend to be revised upwards.

Inflation. The US economy is currently operating at or near full capacity, with labor and capital resource utilization at very high rates. Under these conditions, it is generally believed that the aggregate rate at which the supply of goods and services can grow in the US economy – without causing acceleration of price inflation – is below average. As a result, the above average growth rate of personal spending that was reflected in today’s PCE data, all things being equal, will tend to cause the rate of consumer price inflation to accelerate.

There was a silver lining in the report today, which was that PCEPI services inflation, which has been particularly problematic, decelerated significantly.

Update of Overall Outlook for US Economy

How do these updates to our forecasts for the above macroeconomic conditions affect our overall outlook for the US economy? Currently, the overall outlook for the US economy is dominated by whether or not the US economy will achieve a “soft-landing.” How does our thorough analysis of the just-released PCE data impact the analysis of this question?

The bottom line is that the growth of personal spending is too hot and the overall growth of economic activity is too hot, in the current environment, characterized by supply-side constraints and high inflation. As mentioned earlier, the US economy is currently operating at very high rates of resource utilization. For example, the estimated Non-Accelerating Inflation Rate of Unemployment (NAIRU) is estimated to be approximately 4.2%, and the current unemployment rate at 3.9%. This rate of labor resource utilization, combined with above-average consumer demand growth being reflected in the Personal Spending data, is not compatible with a stable (non-accelerating) rate of inflation.

Another way to describe the current situation is that the growth rate of demand in the US economy is not “landing” in a manner that is conducive to a “landing” of the current too-high rate of inflation down to the Fed’s target rate of 2.0%. Indeed, economic conditions in the US could currently be characterized as indicating a “no landing” scenario.

A no-landing scenario poses no immediate threat to the US economy. However, in the intermediate term, if the growth rate of economic activity does not slow down to a below-average pace that would enable the rate of inflation to “land” at the target rate of 2.0%, then probabilities will increase that the US Fed will intervene in order to bring about a tightening of overall financial conditions. This would raise the risk of a “hard landing” of the economy in the intermediate-term.

Various indicators currently suggest that broad financial conditions are very loose. In large part, this is due to widespread market expectations that Fed monetary policy will ease substantially later in 2024. In particular, fixed-income markets are pricing in between 75 and 100 basis points of Fed rate cuts in 2024, starting in June. However, as a result of the combination of above-average inflationary risks coupled with currently above-average rates of economic activity, we think that current market expectations regarding the extent and timing of Fed easing of monetary policy are likely to be disappointed. Furthermore, we believe there are under-recognized risks to the inflation outlook which could cause a severe tightening of financial conditions. Therefore, we believe that financial markets are generally not sufficiently prepared for the risk that financial conditions could tighten significantly in the second half of 2024.

Concluding Thoughts

Our team at Successful Portfolio Strategy is generally of the view that the overall macroeconomic environment in the US and globally presents good reward-to-risks prospects for a very select group of equities. However, for several months we have been positioning our portfolios in a manner that accounts for likely disappointments of market expectations regarding Fed policy. We are also growing increasingly concerned about inflation risks in the second half of 2024. Indeed, we think that very unusual opportunities are going to emerge in the second half of 2024, starting sometime between June and August.