Quirks in the January data: Income vs. consumption

ECONOMY & POLICY

March 01, 2024

Chief Economist Eugenio J. Alemán discusses current economic conditions.

Personal income increased more than expected in January, up 1.0% (or $233.7 billion). The increase in January closely matches what happened in January of 2023 when it increased by 0.95% (or $213 billion). However, the composition of the increase was very different. In January of 2023, wages and salaries increased by 1.59% (or $179.80 billion). In January of 2024, they did by only 0.36% (or $43.4 billion).

Supplements to wages and salaries increased by 0.59% (or $14.7 billion) in January of this year but increased by 1.1% in January of 2023 (or 26.30 billion). It is true, Personal Consumption Expenditures (PCE) inflation in January of 2023 was double what it was in January of 2024, 0.6% versus 0.3%. However, what made personal income so strong in January of 2024 compared to 2023 was, mostly, personal current transfer receipts, which increased by 2.61% (or $106.4 billion) in January of this year versus a slight decline, of 0.02% (or -$2.10 billion) in January of 2023. Social security payments were up by 3.47% (or $47.7 billion) in January of 2024 compared to 9.12% (or $111.60 billion) in January of 2023. One of the largest differences in personal income was a 4.1% (or $76.0 billion) increase in personal dividend income in January of 2024 compared to 0.98% (or $17.70 billion) in January of 2023.

But there are several things to point out from the personal income release from the income side. First, January’s numbers are probably not going to be repeated, because of the characteristics of January's adjustments to income and because the increase in income was not due to higher wages and salaries, as was the case last year. Second, what we need to check is disposable personal income, and disposable personal income was up by just 0.33% (or $67.6 billion) versus 2.64% (or $508.7 billion) in January of 2023. True, this measure going forward will be highly dependent on the payment of current taxes, which declined by 9.65% (or $295.7 billion) in January of 2023 but increased by 5.95% (or $166.2 billion) in January of 2024. We should not expect current taxes paid to increase by so much in February so disposable income will improve compared to January. However, personal current taxes remained relatively stable during 2023 so if 2023 is a guide, we should not expect them to come down considerably.

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But third and most importantly, markets should not look at nominal numbers, rather, they should look at real disposable personal income, which increased by 2.07% (or $336.80 billion) in January of 2023, but was slightly negative, down 0.02% (or -$2.8 billion) in January of 2024. And this wasn’t a good start to the year compared to last year.

What about consumption or personal consumption expenditures? No quirks, just right, but not quite right! It increased by only 0.2% in nominal terms, which once we adjust for inflation, gives us a decline of 0.1%, which is not a good start of the year.

Of course, this could change in the coming months, but we are faced with income growth that has several quirks that will not be repeated going forward, while consumption… was just weak!

Prime time vs. real time: The Federal Reserve and markets should stay focused

We understand why markets overemphasize the importance put on the Consumer Price Index (CPI) every time it comes out, month after month, about 15 days before the PCE price index is released every month. The early information it provides on the stance of inflation is very important to the market. However, that importance ends at the release. The CPI has no bearing on the Federal Reserve’s (Fed) decision on monetary policy, i.e., on the federal funds rate. The fact that the CPI is NOT used to target inflation by the Fed to conduct monetary policy should be emphasized over and over again. This continues to be the case today when the PCE has been showing a two-handle for several months while the CPI has remained above 3%.

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In the current environment, the fact that shelter costs represent 33% of the weight of the CPI versus about 13% for the PCE price index should help reduce the hype every time the CPI comes out. However, we know that is not going to be what happens.

But even though the CPI is the ‘benchmark’ inflation rate for the markets, the only reason that this is the case is because it comes out earlier than the PCE price index. Giving so much importance to an index because it comes out first is similar to thinking that being first in the roll call every day because your last name starts with an ‘A’ gives you a competitive advantage over others. Perhaps, one of the only exceptions is if you like to be called for jury duty, year-in-year-out or every two years, depending on how the state you are living in determines your selection for this noble duty! Otherwise, markets should pay attention to the PCE price index because – and here we also disagree with other analysts—it is not the ‘preferred’ rate of inflation used by the Fed in conducting monetary policy, it is ‘the’ rate of inflation used by the Fed to conduct monetary policy.

The reason for the PCE price index to be the rate of inflation used by the Fed to conduct monetary policy has to do with the fact that it has the best characteristics to measure the rate of inflation, i.e., it includes all goods and services consumed in the economy and it is not just using a basket of goods. This allows the PCE price index to account for substitution effects in consumption. For example, if the price of a good in the typical basket increases, consumers have the choice to replace it and reduce the impact of the price increase by purchasing a substitute good that is not part of the CPI basket. This cannot be reflected in the CPI because it only includes a fixed, limited, ‘basket of goods’. Looking at the graph on the previous page, it is almost always the case that the CPI tends to overshoot the real rate of inflation, that is, the rate of inflation used by the Fed to conduct monetary policy, the PCE price index. This is especially true when inflation tends to go higher, as the graph clearly shows. When inflation increases, individuals are pushed to look for cheaper alternatives, and thus, we see that the CPI overshoots the PCE price index.

Could we argue that the CPI is a ‘leading indicator’ for the PCE price index? No. The fact that it takes more time, and more information, to gather the effects of price changes for all goods and services rather than for a fixed ‘basket of goods’ does not make the CPI a leading indicator for the PCE price index. Could the CPI give a hint of what is going to come out when the PCE price index is released? Sometimes, but it depends on how effective consumers are in shifting away from higher- priced products to lower priced products, i.e., substitution effects.

Economic and market conditions are subject to change.

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Consumer Price Index is a measure of inflation compiled by the US Bureau of Labor Statistics. Currencies investing is generally considered speculative because of the significant potential for investment loss. Their markets are likely to be volatile and there may be sharp price fluctuations even during periods when prices overall are rising.

Consumer Sentiment is a consumer confidence index published monthly by the University of Michigan. The index is normalized to have a value of 100 in the first quarter of 1966. Each month at least 500 telephone interviews are conducted of a contiguous United States sample.

Personal Consumption Expenditures Price Index (PCE): The PCE is a measure of the prices that people living in the United States, or those buying on their behalf, pay for goods and services. The change in the PCE price index is known for capturing inflation (or deflation) across a wide range of consumer expenses and reflecting changes in consumer behavior.

The Consumer Confidence Index (CCI) is a survey, administered by The Conference Board, that measures how optimistic or pessimistic consumers are regarding their expected financial situation. A value above 100 signals a boost in the consumers’ confidence towards the future economic situation, as a consequence of which they are less prone to save, and more inclined to consume. The opposite applies to values under 100.

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GDP Price Index: A measure of inflation in the prices of goods and services produced in the United States. The gross domestic product price index includes the prices of U.S. goods and services exported to other countries. The prices that Americans pay for imports aren't part of this index.

The Conference Board Leading Economic Index: Intended to forecast future economic activity, it is calculated from the values of ten key variables.

The Conference Board Coincident Economic Index: An index published by the Conference Board that provides a broad-based measurement of current economic conditions.

The Conference Board lagging Economic Index: an index published monthly by the Conference Board, used to confirm and assess the direction of the economy's movements over recent months.

The U.S. Dollar Index is an index of the value of the United States dollar relative to a basket of foreign currencies, often referred to as a basket of U.S. trade partners' currencies. The Index goes up when the U.S. dollar gains "strength" when compared to other currencies.

The FHFA House Price Index (FHFA HPI®) is a comprehensive collection of public, freely available house price indexes that measure changes in single-family home values based on data from all 50 states and over 400 American cities that extend back to the mid-1970s.

Import Price Index: The import price index measure price changes in goods or services purchased from abroad by U.S. residents (imports) and sold to foreign buyers (exports). The indexes are updated once a month by the Bureau of Labor Statistics (BLS) International Price Program (IPP).

ISM New Orders Index: ISM New Order Index shows the number of new orders from customers of manufacturing firms reported by survey respondents compared to the previous month. ISM Employment Index: The ISM Manufacturing Employment Index is a component of the Manufacturing Purchasing Managers Index and reflects employment changes from industrial companies.

ISM Inventories Index: The ISM manufacturing index is a composite index that gives equal weighting to new orders, production, employment, supplier deliveries, and inventories.

ISM Production Index: The ISM manufacturing index or PMI measures the change in production levels across the U.S. economy from month to month.

ISM Services PMI Index: The Institute of Supply Management (ISM) Non-Manufacturing Purchasing Managers' Index (PMI) (also known as the ISM Services PMI) report on Business, a composite index is calculated as an indicator of the overall economic condition for the non-manufacturing sector.

Consumer Price Index (CPI) A consumer price index is a price index, the price of a weighted average market basket of consumer goods and services purchased by households. Changes in measured CPI track changes in prices over time.

Producer Price Index: A producer price index (PPI) is a price index that measures the average changes in prices received by domestic producers for their output.

Industrial production: Industrial production is a measure of output of the industrial sector of the economy. The industrial sector includes manufacturing, mining, and utilities. Although these sectors contribute only a small portion of gross domestic product, they are highly sensitive to interest rates and consumer demand.

The NAHB/Wells Fargo Housing Opportunity Index (HOI) for a given area is defined as the share of homes sold in that area that would have been affordable to a family earning the local median income, based on standard mortgage underwriting criteria.

The S&P CoreLogic Case-Shiller U.S. National Home Price NSA Index measures the change in the value of the U.S. residential housing market by tracking the purchase prices of single-family homes.

The S&P CoreLogic Case-Shiller 20-City Composite Home Price NSA Index seeks to measures the value of residential real estate in 20 major U.S. metropolitan.

Source: FactSet, data as of 7/7/2023