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Strong US consumer spending, inflation readings put Fed in tough spot

Consumer spending in the US is being supported by strong wage gains in a tight labour market. PHOTO: REUTERS

WASHINGTON - US consumer spending increased more than expected in April, boosting the economy’s growth prospects for the second quarter, and inflation picked up, which could prompt the Federal Reserve to raise interest rates again next month.

The growth picture was further brightened by other data from the Commerce Department on Friday showing a surprise rebound last month in orders of manufactured non-defence capital goods excluding aircraft, a closely watched proxy for business spending plans.

The reports added to labour market resilience, a rebound in factory production and a pickup in business activity in suggesting the economy was experiencing a spring revival after hitting a speed bump in the first quarter. They also increased the chances that the US central bank would hike rates in June.

“Companies and consumers are in agreement that there are plenty of green shoots to like at the start of springtime and right now the economy is miles and miles away from the cliffs of recession,” said Mr Christopher Rupkey, chief economist at FWDBONDS in New York.

“Fed officials won’t be able to pause their rate hikes, it looks like demand is picking up, not slowing down as it is supposed to do when the Fed hikes rates.”

Consumer spending jumped 0.8 per cent last month after gaining 0.1 per cent in March. Economists polled by Reuters had forecast consumer spending, which accounts for more than two-thirds of US economic activity, would rise 0.4 per cent.

Consumers stepped up purchases of new light trucks and spent more on pharmaceutical products. Spending on goods rebounded 1.1 per cent after two straight monthly declines.

Services outlays increased 0.7 per cent, lifted by gains in financial services and insurance, healthcare, recreation, and housing and utilities.

Adjusting for inflation, consumer spending shot up 0.5 per cent after being unchanged in March.

Last month’s surge in consumer spending tempered economists’ expectations for a sharp slowdown this quarter. Though consumer spending accelerated at its fastest pace in nearly two years in the first quarter, much of the growth was in January. Sluggishness in February and March set consumer spending on a slower growth trajectory heading into the second quarter.

Consumer spending is being supported by strong wage gains in a tight labour market. Wages increased 0.5 per cent after rising 0.3 per cent in March. That helped lift personal income 0.4 per cent after a gain of 0.3 per cent in March. Growth estimates for the second quarter are currently as high as a 2.9 per cent annualised rate. The economy grew at a 1.3 per cent pace in the first quarter.

Stocks on Wall Street were trading higher. The dollar edged up against a basket of currencies. US Treasury prices were mixed.

Imports surge

Strong demand was underscored by another report from the Commerce Department showing imports of goods climbed 1.8 per cent in April, mostly reflecting motor vehicles and consumer goods. But the rising imports and a 5.5 per cent drop in exports caused the goods trade deficit to widen 17 per cent to US$96.8 billion (S$130 billion), a development that could subtract from growth this quarter.

The current pace of consumer spending is, however, unlikely to be sustained as Americans grow weary of inflation.

Government social benefits are also dwindling and most lower-income households have depleted the savings accumulated during the Covid-19 pandemic. The saving rate fell to 4.1 per cent in April from 4.5 per cent in March.

Credit has also become more expensive following 500 basis points worth of rate increases from the Fed since March 2022, when it embarked on its fastest monetary policy tightening campaign since the 1980s to tame inflation.

Banks are also tightening lending following recent financial market turmoil spurred by the collapse of several US lenders.

The personal consumption expenditures (PCE) price index increased 0.4 per cent in April after rising 0.1 per cent in March. In the 12 months through April, the PCE price index increased 4.4 per cent after advancing 4.2 per cent in March. Food prices were unchanged, while the cost of energy goods and services jumped 0.7 per cent.

Excluding the volatile food and energy components, the PCE price index was up 0.4 per cent after a 0.3 per cent rise in March. The so-called core PCE price index jumped 4.7 per cent on a year-on-year basis in April after gaining 4.6 per cent in the 12 months through March. The Fed tracks the PCE price indexes for its 2 per cent inflation target.

Economists estimated that core services excluding housing, closely watched by policymakers, increased 0.4 per cent after rising 0.3 per cent in March.

There was, however, some encouraging news for Fed officials. Consumers’ inflation expectations over the next 12 months dropped to a final reading of 4.2 per cent in May after spiking to 4.5 per cent earlier in the month, a survey from the University of Michigan showed. The five-year inflation outlook eased to 3.1 per cent from 3.2 per cent in early May.

Financial markets saw a nearly 60 per cent chance of the Fed raising its policy rate by another 25 basis points at its June 13-14 meeting, according to CME Group’s FedWatch Tool. Much will, however, depend on whether an agreement is reached to raise the government borrowing cap. April’s employment report next Friday as well as consumer price data will also be crucial.

“If the debt ceiling is resolved without too much damage to sentiment, and banking troubles don’t resurface, then the broad sweep of data so far could make for an interesting debate at next month’s meeting, though we still believe the Fed will leave rates unchanged,” said Mr Michael Feroli, chief US economist at JPMorgan in New York.

In another report, the Commerce Department said orders for non-defence capital goods excluding aircraft surged 1.4 per cent last month after falling 0.6 per cent in March, confounding economists who had expected a 0.2 per cent drop. Shipments of these so-called core capital goods rebounded 0.5 per cent after slipping 0.2 per cent in March.

“This supports a pickup in business investment,” said Kathy Bostjancic, chief economist at Nationwide in New York. REUTERS