Commerce Department data released Friday showed that although the Federal Reserve’s preferred price gauge didn’t budge from its 2.6% annual rate seen a month before, a closely watched measurement of underlying inflation dropped to its lowest level since March 2021.
Additionally, the American household closed out 2023 on strong footing: Incomes and wages were up considerably from the year before, and consumers continued to spend heartily to keep the economy growing and casting aside recession fears.
“The American household continues to demonstrate resilience in light of these shocks,” said Joe Brusuelas, principal and chief economist at RSM US. “One can’t help but be somewhat optimistic about the American economy going forward, given the fact that we are at the doorstep of price stability, and the inflation fight has essentially ended.”
The Personal Consumption Expenditures price index — the inflation gauge that the Fed uses as its target rate — was up 2.6% annually in December, closing out 2023 with a softer punch than the 5.4% gain a year prior, according to Commerce Department data released Friday. December’s inflation reading is 0.6 percentage points from the central bank’s goal of 2%.
Excluding energy and food, components that tend to be more volatile, the closely watched core PCE price index rose 2.9% annually, a slower pace than the 3.2% rate seen in November.
The core PCE gauge is at its lowest point since March 2021. While the headline index is the official base for the target rate, Fed Chair Jerome Powell and other policymakers often highlight core PCE inflation as it’s generally considered a better signal of where inflation is headed.
And as of now, “we’re still headed in the right direction,” Dana Peterson, chief economist at the Conference Board, told CNN in an interview.
“Inflation is heading where the Fed wants it to, and I think they’re going to have greater confidence that they can start removing some of the restrictive policies,” she said.
The steps to 2%
On a monthly basis, the headline PCE index rose 0.2%, a slight acceleration from the 0.1% drop seen in November when gas prices were tumbling. The core PCE index also rose by 0.2% from the prior month.
Consumer spending finished the year strong and was up 0.7% from November 2023, according to Friday’s report. Adjusting for inflation, spending was up 0.5%.
Economists had projected PCE would rise 2.6% for the 12 months ended in December and for consumer spending to grow 0.5% from the month before, according to FactSet estimates.
Since March 2022, the Fed has raised its benchmark rate 11 times in an aggressive campaign that has brought interest rates to 23-year highs. However, Fed policymakers have held pat during their past three meetings and are expected to take a similar approach next week before cutting back on those rates slowly but surely this year.
On the goods side, any inflationary pressures from food, beverages and other non-durable items — like plastics, clothing and rubber — are being essentially canceled out by disinflation (prices rising at a slower pace) or outright deflation (prices falling) for gasoline, recreational goods, furniture and other durables, Peterson noted.
On the services side, the biggest driver remains shelter costs. But those are improving, Peterson said.
“What I do is I look at the [S&P CoreLogic] Case-Shiller home price index, and lag it 18 months,” she said. “Case-Shiller tells you that there’s going to be continued slowing and thereby shrinkage in the contribution of shelter costs to inflation. That’s good news; that’s going to take us a long way to getting back to 2%.”
Other contributors of inflation within services include home and auto insurance costs that have risen because of weather-related losses, and rising prices in high-demand experiential services businesses like restaurants and hotels that have increased wages to address worker shortages.
Geopolitical uncertainty and how that could spill over to energy and transportation costs remain potential risks; however, energy prices are currently down 5.4% on a three-month annualized basis, Brusuelas said.
“It’s good to note the risks, but we don’t want to get lost in the forest by focusing on a couple of trees,” he said.
Americans are ‘seeing their fortunes improve’
Americans’ personal incomes continued to grow in December, rising 0.3% from the month before. Savings shrank during the key holiday shopping month, landing at 3.7% of disposable income, down 0.4 percentage points from November, according to the report.
On an annual basis, income is up 4.7%, compensation up 6.5%, wages and salary are up 6.8% and disposable income is up 6.9%, Brusuelas said.
“One cannot escape the fact that it is a rock-solid foundation, and that the American household continues to demonstrate resilience in light of these shocks,” he said.
Plus, as households’ disposable income improves, so does their sentiment, he said, noting that “puts a floor underneath the American economy.”
He added: “We ain’t having no recession.”
Brusuelas’ comments about sentiment echoed those of Treasury Secretary Janet Yellen, who on Thursday delivered a major speech about the economy and the administration’s efforts in 2024.
“There was a period in which [decades-high inflation] was of great concern, and prices for a while increased more than wages,” Yellen said during a fireside chat following her speech at the Economic Club of Chicago. “Now, the opposite is true: Wages are now increasing at a faster rate than inflation, people are getting ahead, they’re seeing their fortunes improve.”
She added: “And I believe that if inflation stays low, they’ll begin to regain their confidence in the economy, and I believe we’re seeing that’s possible.”
There’s typically about a six-month lag before improving economic data spills over into consumer confidence measures, Brusuelas said. Recent consumer data from the University of Michigan and the Conference Board have shown a rebound in people’s attitudes about the economy.
That should continue, Brusuelas said, not only because of potential easing on the Fed’s side, but the policies put forth by the Biden administration.
“We had a supply-driven induced inflation shock, and what was the policy response? Time, and an increase in supply, infrastructure, supply chain resilience and environmental sustainability, all adding supply to the market,” he said. “And look what happened. They do deserve serious credit here.”
He added: “The Federal Reserve addressed the demand side of the equation; the administration addressed the supply side.”
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