Economic Commentary

Spending still too hot and debt-limit negotiations continue: Weekly Economic Review & Outlook

May 30, 2023
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Key Takeaways:

April personal consumption expenditure data showed that inflation picked up as spending activity was very strong — both counter to the Fed’s goal of slower demand and price increases. There will be another employment and CPI report before the mid-June FOMC meeting, but the odds of a further rate hike are climbing. Also, debt ceiling negotiations carried on into Memorial Day weekend as the projected deadline to lift the debt limit looms.

What we learned last week: (pg. 1)

Services inflation climbs in April

Super core inflation (core services less housing) climbed in April and has shown no signs of slowing in recent months.

Consumer activity on the rise

Consumer spending in April was the highest in three months, boosted by spending on durable goods (particularly autos).

Debt-limit negotiations are ongoing

The White House and the leaders of Congress reached a deal to temporarily suspend the $31.4 trillion debt ceiling limit through January 2025. (see more below)

What we’re watching this week: (pg. 2)

June 1: ISM Manufacturing

Further contraction in the manufacturing sector

The ISM manufacturing index should show continued contraction in the manufacturing sector as businesses reduce plans for future investment amid falling sales. Manufacturers have added few workers so far in 2023 as production wanes but most are not yet looking to reduce staffs. Input prices have increased in recent months with several key components still in short supply, adding to production costs. The overall ISM index should dip further to 46.7 in May, extending the string of contractionary readings to seven months.

June 2: Job gains should remain buoyant, led by services

Income, spending should rise despite persistent price pressures

Hiring likely remained solid in May with 205,000 added jobs expected over the month, moderately less than April’s 230,000 gain. The unemployment rate, which matched the lowest level since 1969 in April at 3.4 percent, should tick higher in May to 3.5 percent — but this still indicates very tight conditions which underpins buoyant gains in average hourly earnings. Reentry of workers in recent months has helped to modestly improve the supply of workers but there continues to be about 1.6 job openings per every unemployed job seeker.

Analysis: Debt-limit negotiations are ongoing

As of the time of writing this review, the White House and the leaders of Congress reached a deal to temporarily suspend the $31.4 trillion debt ceiling limit through January 2025, after the next presidential election. The bill will now need to be passed by the House and Senate this week before the revised June 5th “X” date — the day that the Treasury Department could exhaust its cash on hand and extraordinary measures (implemented to make room under the debt limit to allow Treasury to raise funds via debt auctions).

But even getting this close to a possible default on U.S. financial obligations has increased volatility in bond and equity markets. Rating agency Fitch put the U.S. AAA credit rating on negative watch, citing the imminent risk of a debt default. If the bill is not passed in time, we expect the Treasury to prioritize its financial obligations and cover incoming debt interest and maturity payments. However, even though the Treasury would avoid defaulting on debt payments, once its cash on hand is fully depleted it will need to reduce the amount of Federal spending to match revenues. This would lead to a further tightening of fiscal policy which will weigh on economic growth — in addition to expected sharp declines for equity prices and much higher interest rates. This would be highly disruptive for the economy and financial markets. At a time when growth conditions are broadly weakening, the hit to incomes and spending from a debt default could be the final blow to push the economy into a recession despite the current strength in consumer spending.

Analysis: Inflation and spending both strong in April

The headline and core PCE price indices each climbed 0.4 percent in April — a little faster than consensus forecasts — to lift the 12-month trend rates to 4.4 percent and 4.7 percent, respectively. Core services less housing (super core inflation) posted its largest month-over-month gain since January, highlighting the sticky nature of inflation pressures and increases the chances of another rate hike at the June FOMC meeting.

Consumer spending was hotter than expected in April, with growth coming in at 0.8 percent — the fastest monthly increase since January and second-fastest of the last 15 months. Even when adjusting for inflation, real spending (+0.5 percent) was quite strong and indicative of a solid start for economic activity in the second quarter. Real spending on services was solid, climbing by 0.3 percent, but it was the goods sector that led way in April. Real durable goods spending climbed by 1.4 percent (boosted by a surge in autos of 13.1 percent), leading to overall growth for goods of 0.8 percent.

Personal incomes also climbed, but not enough to support this level of spending. Real income growth for the month was flat, which means consumers dipped into savings to support their spending; the personal saving rate fell in April to 4.1 percent from 4.5 percent in March. Consumers continue to tap into excess savings built up during the pandemic, which was estimated by the San Francisco Fed to still be around $500 billion.


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