Connor Hare

• Revisions to economic growth in the first quarter featured a mark down to consumer spending in financial news.
• That theme continued in April, where a contraction in real personal consumption expenditures came as a confirmation that restrictive rates are working.
• Inflation also took another step in the right direction. But sticky services inflation still has room to fall before the Fed can feel confident that inflation has been tamed.

Bond yields are climbing down from this week’s highs as a pair of high-profile data releases suggest the some of the steam is being let out of the U.S. economy in financial news. While there isn’t anything released this week that is going to meaningfully move the needle on the timing of the Fed’s decision, it was encouraging to see that the current restrictive policy stance is cooling the economy. That said, there is still enough strength underlying the economy to keep the Fed’s policy rate right where it is until later this year.

First up was the refresh of the first quarter’s GDP data. Top-line economic growth was shaved down a smidge, to a below trend 1.3% quarter-on-quarter (q/q, annualized) change. Consumer spending too was marked down, from 2.5% to a more trend-like 2.0%. That said, faced with persistently strong price growth and high interest rates, the ability of households to keep buying stuff and spending money on experiences has defied expectations. Specifically, the shift back to services spending has kept demand up on the primarily domestic portion of the economy facing a tight labor market. Moreover, there is room for this trend to run if households continue to adjust their expenditures back towards a pre-pandemic mix, where household services consumption accounted for just shy of 66% of personal consumer expenditures (compared to 64.6% as of April, Chart 1).

So, it came as a welcome surprise that April’s Personal Consumption and Expenditures (PCE) survey showed real PCE pull back 0.1% month-on-month (m/m). More good news came as the core PCE deflator edged down to 0.2% m/m, leaving the annual pace of price growth to 2.8%. That said, the three- and six-month core PCE inflation rates are still 3.5% and 3.2% (annualized), respectively, as the past few months of strong price growth continue to be felt.

Importantly, while the deceleration in core price growth was welcome, special attention has to be paid to rents and housing costs that have been propping up core price growth. Together the two categories make up roughly 15% of PCE and will be critical to taming inflation. On this front, there was only marginal relief in April. Rent inflation came in at a “soft” 0.4% m/m (the print was 0.35% m/m unrounded). This is in line with the average reading from the prior five months (Chart 2). On the homeownership side too, implied rents came in at the same 0.4% m/m, roughly unchanged from the last few months. Sustained over a year, the 0.4% monthly pace would translate to 4.9% annual growth. The annual rates on the two shelter components are now cruising along at 5.7% and 5.4% for the imputed and actual rent measures, respectively.

For the Fed, April’s data were a step in the right direction, but there is still more work to be done before rate cuts become imminent. So now, all eyes are focused on data coming next week, and specifically the May payrolls report. After April’s real spending and payrolls data surprised to the downside, the focus will be for any signs that the month was not a one-off and weaker momentum continued into May.

Andrew Hencic, Senior Economist | 416-944-5307

After last week’s Federal Reserve decision and employment report, the second week of May was comparatively lighter on data releases. First quarter reports for lending activity and consumer credit showed that tighter lending standards continue to weigh on credit demand. However, financial markets were more attentive to the comments of Federal Reserve officials as they sought insights on the potential path of monetary policy moving forward. As of the time of writing, the S&P 500 was up 2.1% on the week, while Treasury yields were roughly unchanged.

Starting things off on Monday, we received the updated Federal Reserve Senior Loan Officer Opinion Survey (SLOOS) for the first quarter. Survey responses showed that banks continued to tighten lending standards and report weaker demand for loans across all business and consumer loan categories. Relative to the fourth quarter of 2023, more banks tightened lending standards for consumer credit, fewer tightened commercial and residential real estate credit, and roughly the same number of banks tightened commercial & industrial credit in financial news. Within consumer credit, tighter lending standards pushed the net share of banks reporting stronger demand for credit cards to its lowest level since mid-2020 (Chart 1).

Looking at the monthly breakdown for consumer credit, the March data showed consumer credit growth decelerated considerably through the first quarter as interest rates trended higher (Chart 2). While consumer credit still expanded 3.2% (annualized) in the first quarter, the gains were largely front-loaded in the earlier months and tapered off as financial conditions tightened. With interest rates continuing to push higher through the first half of the second quarter, it seems likely that a further softening in consumer credit growth will occur over the coming months. Combined with depleted pandemic excess savings, weakening consumer credit growth is expected to lead to moderating consumption growth in 2024. While this should aid the Federal Reserve in their attempts to return inflation to their 2% target, officials emphasized their vigilance in recent remarks.

Vice Chair and New York Fed President John Williams noted this week that monetary “policy is in a very good place, and we have the time to collect more [data], so steady as she goes”. This sentiment was echoed by Richmond Fed President Barkin who stated his optimism that “today’s restrictive level of rates can take the edge off demand in order to bring inflation back to our target”. Most members noted that they did not expect further policy tightening to be necessary, with Minneapolis Fed President Kashkari stating that “the bar for us raising is quite high, but it’s not infinite”. While the prospect for higher rates is unlikely at this time, Fed officials are expected to remain vigilant against the potential for upside risks to inflation.

April’s Consumer Price Index report next week will offer the next barometer on inflation trends as the Fed prepares to update their Summary of Economic Projections ahead of their next meeting on June 11-12th.

Andrew Foran, Economist | 416-350-8927