The latest inflation report from the Commerce Department brought some good news for the US economy and the Federal Reserve: The high inflation that has plagued the country for most of 2023 may be finally easing.
The report, released on Friday, showed that the annual inflation rate, measured by the Personal Consumption Expenditures (PCE) price index, stayed at 2.6% in December, the same as in November. This was lower than the 5.4% inflation rate recorded a year ago and closer to the Fed’s target of 2%.
The PCE price index is the Fed’s preferred inflation gauge, as it reflects the changes in the prices of goods and services that consumers actually buy. The Fed also pays attention to the core PCE price index, which excludes food and energy prices, as it is considered a better indicator of the underlying inflation trends. The core PCE price index dropped to 3.9% in December, the lowest level since March 2021.
The inflation report suggests that the Fed’s efforts to tame inflation by raising interest rates 11 times since March 2022 have been practical. The Fed has also signalled that it will start reducing its bond-buying program, which has pumped trillions of dollars into the economy, in early 2024.
The lower inflation rate also means that consumers have more purchasing power, as their incomes and wages have increased faster than the prices of goods and services. This is a positive sign for the economic recovery, as consumer spending accounts for about 70% of the US gross domestic product (GDP).
Consumer spending remains strong despite inflation
The Commerce Department report also showed that consumer spending rose by 0.7% in December, beating the market expectations of 0.5%. After adjusting for inflation, real consumer spending increased by 0.5%.
The strong consumer spending in December reflects the resilience of the American household despite the challenges posed by the COVID-19 pandemic, the supply chain disruptions, and the high energy prices. Consumers have been able to maintain their spending habits by tapping into their savings, using credit cards, or receiving government stimulus checks.
The report also revealed that personal income increased by 0.4% in December, slightly lower than the 0.5% rise in November. However, compared to a year ago, personal income was up by 6.4%, while wages and salaries were up by 8.8%. These figures indicate that the labor market has improved significantly, as employers have raised wages to attract and retain workers amid labor shortages.
What does the inflation report mean for the future?
The inflation report for December is a welcome relief for the US economy, as it shows that inflation is moving in the right direction and that consumers are still confident and willing to spend. However, the report does not mean that the inflation problem is over or that the Fed can relax its monetary policy stance.
The inflation rate is still above the Fed’s target of 2%, and there are still some inflationary pressures in the economy, such as the rising costs of food, housing, health care, and transportation. The Fed will have to balance its policy decisions between keeping inflation under control and supporting the economic recovery.
The Fed is expected to hold its interest rates steady at its next meeting on January 25-26, but it may announce more details about its plans to reduce its bond-buying program. The Fed is also likely to revise its inflation and growth forecasts for 2024 based on the latest economic data.
The inflation report for December is a positive sign for the US economy, but it is not a guarantee of future success. The economy still faces many uncertainties and risks, such as the COVID-19 variants, geopolitical tensions, environmental issues, and fiscal policy changes. The Fed and the consumers will have to remain vigilant and flexible as the economic situation evolves.
“What I do is I look at the Case-Shiller home price index, and delay it by 18 months,” Conference Board’s chief economist Dana Peterson said in an interview with CNN. “Case-Shiller shows that there will be more slowing and less impact of housing costs on inflation. That’s good news; that will help us reach 2%.”
Other sources of inflation in services are home and car insurance costs that have gone up due to weather-related damages and higher prices in popular experiential services sectors like restaurants and hotels that have raised wages to deal with worker shortages.
Geopolitical uncertainty and how that could affect energy and transportation costs are still possible threats; however, energy prices are currently down 5.4% on a three-month annualized basis, said Brusuelas, the leading economist and principal at RSM US.
“It’s good to be aware of the risks, but we don’t want to miss the big picture by focusing on a few details,” he said.
Americans are ‘improving their fortunes’. Americans’ incomes kept growing in December, increasing 0.3% from the previous month. Savings dropped during the critical holiday shopping month, reaching 3.7% of disposable income, down 0.4 percentage points from November, according to the report.
On a yearly basis, income is up 4.7%, compensation is up 6.5%, wages and salary are up 6.8%, and disposable income is up 6.9%, Brusuelas said.“One cannot deny the fact that it is a strong foundation and that the American household continues to show resilience in spite of these shocks,” he said.
Also, as households’ disposable income gets better, so does their sentiment, he said, noting that “puts a support under the American economy.”
He added: “We are not having a recession.”
Brusuelas’ remarks about sentiment matched those of Treasury Secretary Janet Yellen, who gave a major speech on Thursday about the economy and the administration’s efforts in 2024.