Consumer Retrenchment in Goods Spending, Inflation Mild
January’s personal income and spending report was full of surprises. Income came in hot growing 0.9% which was more than double the expected gain of 0.4%. Spending fell on both a real and nominal basis. The decline is the first in 22 months though it does come on the heels of upward revisions to December data.
We have been cautioning about some potential pull-forward in goods spending as consumers try to squeeze in big-ticket purchases before tariffs go into effect. At some point we feared there would be payback. January is sooner than we would have expected to see it. Yet, how else to explain the fact that among the categories posting a decline in January seven out of the top eight decliners were goods categories.
The bottom dropped out beneath motor vehicles & parts spending with a $41.1 billion dollar decline. For most households, this is the definition of a major outlay and the category had seen decent strength rising 3 out of the past 5 months. Recreational goods and RVs made up the second largest decliner in January spending followed by other non-durable goods. Other goods categories in the red included clothing & footwear as well as food & beverages. In fact, the only goods category to post a gain was gasoline and other energy goods, a mostly price-related development.
Source: U.S. Department of Commerce and Wells Fargo Economics
The pop in overall income is partially attributable to one-off factors that typically impact the start of the year. The first is the annual cost of living adjustment (COLA) to social security, which drove this portion of income up 2.8% in January, and accounted for two-tenths of the overall gain in income. Strength can also be traced to receipts on assets and proprietors income.
Yet all of the strength can’t be talked away. Wages & salaries, which comprises a bulk of households income and thereby spending power were also up a strong 0.4%, adding to a string of solid gains the past three months consistent with a sturdy labor market. All told, in adjusting for inflation and taxes, real disposable personal income rose 0.6% in January, or at the fastest pace in a year.
Inflation is still a challenge not just for the Fed but for consumers looking to spend on discretionary items. Earlier this month we learned the CPI surprised to the upside and this morning’s data show the Fed’s preferred measure of inflation, the PCE deflator, rose 0.3%, which was enough to drive the year-over-year rate lower to 2.5%. Goods inflation (+0.5%) outpaced services inflation (+0.2%) for the first time in at least six months.
The core measure (excluding food and energy) was up a similar amount in January, which drove the annual rate down to 2.6% from an upwardly revised 2.9% in December. On a three-month average annualized basis, core inflation sits at 2.4% today.
While risks today look skewed to the upside around inflation, the pricing environment remains highly uncertain. Consumers are price fatigued, and major retailers have acknowledged this. Tariffs are the most obvious threat to the pricing environment and the last few tenths to the Fed’s 2% target remain in the crosshair.
Source: U.S. Department of Commerce and Wells Fargo Economics
Consumer spending has been a stalwart driver of economic growth throughout the current expansion. Yesterday’s Q4 GDP revisions lifted the annualized rate of consumer spending to a blistering 4.2%, the second fastest quarterly expansion in consumer spending in the past three years. Today’s report does not fundamentally alter our thinking on the sustainability of consumer spending though it does offer a look at what consumer life might look like in a world where goods spending is put on ice.
Americans were actually not retrenching in January other than in their homes.
The sharp declines in goods, particularly in motor vehicles and RV sales, are mostly weather related. Wards’ estimates that February light vehicle sales were +1.9% MoM, +1.5% YoY.
In fact, their spending power improved. Wages and Salaries rose 0.4% MoM and +5.5% annualized in the last 4 months. Aggregate weekly payrolls are up 4.9% during the same period.
Total expenditures were up 5.5% YoY in January, +5.6% on average in the previous 4 months.
Core PCE inflation came in at +0.28% MoM, +3.5% annualized, thankfully nowhere close to the 5.5% a.r. spike in core CPI.
Averaging both measures, inflation seems stuck around 3.0% for now. With income rising 5.0-5.5%, real expenditures should grow 2.0-2.5% unless tariffs or fear interferes…
Fed Paper Finds Tariffs May Raise US Consumers’ Everyday Costs
President Donald Trump’s proposed tariffs on imports from China, Mexico and Canada could lead US consumers to face higher prices on everyday purchases, according to new research published Friday.
The final cost to consumers will depend on how much of the tariffs are passed on to end consumers by companies. Prices on a portion of consumer expenses could rise by 0.81% if businesses pass through half of the tariff costs, or by 1.63% if they fully transfer the expenses, according to new research from the Federal Reserve Bank of Atlanta. (…)
A look at the tariffs enacted against China in 2018 and 2019 by the first Trump administration shows the levies were fully passed through to import prices. (…)
Actually, the Atlanta Fed research says that the new tariffs would directly hit “about a quarter of the total consumption basket” by between 0.81% and 1.63%, importantly adding that “the aggregate effect on the overall Consumer Price Index (CPI) further hinges on the price sensitivity of the remainder of the excluded consumption categories, particularly transportation, services, energy, and housing.”
So +0.8-1.6% is the minimum cost increase on everyday purchases, hitting almost immediately, with no account for categories beyond the scope of the research that will be hit gradually as importers pass their cost increases through the supply chains.
The paper adds:
In terms of the timing of the price effects, recent studies indicate that tariff effects are both immediate and persistent. Collectively, these findings imply that future tariffs are likely to be transmitted swiftly to retail prices and have lasting impacts. (…)
Moreover, for two key reasons, our estimates in this paper should be viewed as a lower bound. First, tariffs can affect prices indirectly through input-output linkages, amplifying their impact beyond the direct pass-through captured in our analysis. Second, for Canada and Mexico, we rely on aggregate import shares and do not account for firm-level heterogeneity in expenditure shares and import dependence. If firm-level expenditure shares positively correlate with import dependence, our aggregate estimates for Canada and Mexico likely underestimate the true price effects.
For example, as the WSJ explains,
Tariffs on Mexican-made cars would likely mean not just higher prices for vehicles shipped across the border, but on all cars as other manufacturers and dealers see a chance to eke out more profit while gaining market share. (…)
Washing machines were hit with tariffs in 2018, which researchers found led to an increase in the price not just of washing machines but dryers also. The two are typically bought together, and retailers saw an opportunity to earn more.
The study also found that prices of domestically made, not just imported, washers rose, as manufacturers raised prices owing to higher labor costs and tariffs on imported parts, and to match price hikes on imported machines.
Keep in mind that categories excluded from the research, covering 75% of the consumption basket, include autos and parts (18% come from Canada and Mexico), lumber (24%), crude oil (26%), natural gas (8%) and electricity (1%) (tariffs on energy are 10%).
The BLS will release the March and April CPI data on April 10 and May 13 respectively.
As to the actual release of tariffs on Canada-Mexico, due tomorrow,
he’s sort of thinking about right now how exactly he wants to play with Mexico and Canada and that is a fluid situation,” [Commerce Secretary Howard] Lutnick said on Fox News’ Sunday Morning Futures, speaking of Trump. “There are going to be tariffs on Tuesday on Mexico and Canada, exactly what they are, we’re going to leave that for the president and his team to negotiate.”
“Play”!!!
Investor focus needs to shift from core inflation to headline (total) inflation because spending power must now be closely monitored as tariff inflation hits many essential goods and services, threatening economic growth.
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The labor market has shifted from steady to volatile and increasingly dependent on wages (vs jobs and hours) to sustain labor income growth.
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Since 2021, labor income easily outpaced PCE inflation …
- … but more erratically in 2024 and negatively in December 2024 and January 2025 when 3-5-4.0% inflation outpaced 2.5-3.0% labor income growth.
PCE inflation in the 4-5% range would squeeze (and anger) Americans.
In my Feb. 10 Daily Edge I showed that consumer expenditures have become increasingly dependent on wage growth to compensate for slowing gains in jobs.
Important? Not if employment does not slow down more and not if inflation remains well contained. But the seemingly solid American consumer is on somewhat shakier grounds as buffers against potential troubles in the labor market (jobs/wages) or higher inflation (tariffs) have weakened in recent months.
I also noted that 88% of the new jobs created in 2023 and 2024 were in only 3 sectors (Education and Health Services, Governments and Leisure and Hospitality). That leaves only 12% of jobs creation from all other activities which together account for some 50% of all jobs.
- The first 2 sectors are targets of the DOGE boys.
- We don’t know what the damage will be but recent trends in unemployment claims are bad:
For consumers and the overall economy, slowing employment and broadly higher tariffs may prove unsettling.
Meanwhile:
Euro-Zone Inflation Cools as ECB Enters Final Phase of Cuts Consumer prices rose 2.4% from year ago in February
(…) While still elevated, services inflation — which policymakers have been paying particular attention to — dipped to 3.7%. That’s the first major retreat from 4% since April 2024. (…)
Durables Pop May Say More About Tariffs than Underlying Demand
In what may be a bid to get ahead of tariffs, new durable goods orders exceeded expectations with outperformance particularly evident in core capital goods orders.
New orders for durable goods jumped 3.1% in January, which came with upwardly revised data that show a less-bad drop at the end of last year (-1.8% versus -2.2% previously reported). Much of this month-to-month volatility can be traced to aircraft orders specifically reflecting a turbulent net orders trend at Boeing as strike-related challenges work their way through activity.
The aircraft noise is not the only factor. When is comes to business investment, it is difficult to get a clean read on what is happening in the U.S. economy at present. In GDP revisions separately released [last week] we learned that equipment spending cratered in the fourth quarter, falling at a 9% annualized rate (down from the previously reported 7.8% drop). How do we square that with this apparent resurgence in durable goods orders?
Core cuts of the orders data suggest a more stable trend in underlying activity. Excluding the broader transportation sector, durable goods orders were flat in January. If we look at nondefense capital goods orders excluding aircraft specifically, orders were up 0.8%, building on a prior month increase and showing a decent pickup off of a stalled two-year trend. This cut of core capital goods orders has now advanced at the fastest pace on average in three months since mid-2022.
Part of the advance in underlying orders may reflect a pull-forward in demand ahead of potential tariff threats, as purchasing managers stockpile not just imported but domestic goods as manufacturers source a lot of their inputs from abroad. To the extent this pickup in core capital goods orders does reflect a pull forward in demand, we should brace for some payback as that intention subsides mid-to-late in the year.
The recent improvement should manifest in near term growth, but it’s hard to see conditions overly supportive of a broad and sustained recovery in capex spending amid elevated uncertainty and still-high rates. The durable goods shipments data give us the early read on how equipment investment is faring for Q1 and to say these data have been volatile is an understatement.
Despite the Q4 drop in real equipment spending, which was due largely to weakness in aircraft shipments, core capital goods shipments including aircraft jumped in December, up 3.8% after four consecutive monthly declines. Shipments were strong again in January, with this measure up 3.2%, which suggests we’re set up to see a rebound in first quarter equipment investment.
China Factory Activity Returns to Expansion But Trade Risks Grow
The official manufacturing purchasing managers’ index was 50.2, versus 49.1 in January, the National Bureau of Statistics said Saturday. The median forecast of economists surveyed by Bloomberg was 49.9. A number above 50 points signals growth.
The non-manufacturing measure of activity in construction and services rose to 50.4 from 50.2 last month, the statistics office said. That’s in line with the forecast of 50.4.
Also, the production subindex rose to 52.5 in February, compared with 49.8 in January. The subindex for total new orders rose to 51.1 in February, compared with 49.2 in January, while the gauge for new export orders remained in contractionary territory for the tenth straight month, but rose to 48.6, compared with 46.4 in January.
The private Caixin Manufacturing PMI
improved to a hree-month high of 50.8 in February. That was up from January’s 50.1 and, although indicative of only a marginal improvement in operating conditions, represented the best outcome for the headline index since last November. (…)
Growth rates for both output and new orders were their best since last November. Panellists reported that a general improvement in economic conditions and the introduction of new products had supported the fifth successive monthly increase in total new orders.
Demand strengthened from foreign clients, according to panellists, with new export business rising modestly for the first time since last November.
(…) output charges declining slightly in February for a third month in a row.
Japan Manufacturing PMI:
Operating conditions deteriorate for eighth monthin a row
Japanese manufacturing production fell further at the midpoint of the first quarter of 2025, though both output and new order inflows decreased at softer rates. The pace of reduction was only modest, but often attributed to weak sales and confidence in domestic and overseas markets. The subdued manufacturing performance was also reflected in a broad stagnation in employment levels and solid falls in purchasing activity and backlogs of work.
On the price front, input costs continued to rise at a robust rate that was the joint-strongest since last August (with December 2024). In response, manufacturers raised their selling prices at a faster rate.
EARNINGS WATCH
From LSEG IBES:
482 companies in the S&P 500 Index have reported revenue for Q4 2024. Of these companies, 63.5% reported revenue above analyst expectations and 36.5% reported revenue below analyst expectations. In a typical quarter (since 2002), 62% of companies beat estimates and 38% miss estimates. Over the past four quarters, 62% of companies beat the estimates and 38% missed estimates.
In aggregate, companies are reporting revenues that are 1.2% above estimates, which compares to a long-term (since 2002) average surprise factor of 1.3% and the average surprise factor over the prior four quarters of 1.2%.
The estimated earnings growth rate for the S&P 500 for 24Q4 is 16.9%. If the energy sector is excluded, the growth rate improves to 20.4%.
The estimated revenue growth rate for the S&P 500 for 24Q4 is 5.2%. If the energy sector is excluded, the growth rate improves to 5.8%.
The estimated earnings growth rate for the S&P 500 for 25Q1 is 8.1%. If the energy sector is excluded, the growth rate improves to 9.6%.
Trailing EPS are now $245.28. Full year 2025: $270.46e. Forward EPS: $270.29e.
Revisions are still downward…
…mainly on consumer-centric and financial companies:
- “We trim our 2025 EPS growth forecast from 11% to 9% and maintain our 2026 forecast of 7%. Our revision reflects the fact that EPS growth in 2024 was stronger than expected but economic data in 2025 have been softer than expected…..economic data in 2025 have been slightly weaker and the tariff outlook slightly more hawkish than we expected.” (GS)
Cash or no cash?
- Professional investors? “Look Ma, No Hands!
- Berkshire:
Is this why all that Buffett cash?
Where’s the Risk Premium? On the other hand, the current level of policy uncertainty (and it is very real, we are in very unusual territory here with tariff risk, government reforms and fiscal contraction, geopolitical shifts, and a frenzied pace of activity and announcements by the new admin… there is a real uplift in uncertainty and greater volatility) — Normally the way these two lines travel you’d want to see an Equity Risk Premium at least twice that of the current. You can get that by either dropping the 10-year yield to about 2% or by chopping stockmarket valuations in half… or some combination thereof (neither good!)
Oh and for completeness, since that ERP has long-term inflation in it too, you could also get there via a 20% increase in CPI [also not good, and also likely to do bad things to bond yields and stocks!]
(Callum Thomas)
Source: Topdown Charts Professional
Speaking of cash or no cash: “America’s net interest payments on our debt are the highest among OECD nations, nine times higher than Japan’s (which has both greater debt as a share of GDP and a smaller economy!) China spent 0.96% of their GDP on interest payments last year, 1/4th America’s burden.” (Callum Thomas)
A reverse trade deficit that, maybe, better not be reversed! Foreign purchases of US equities has far exceeded domestic buying:
Source: Simon White
Here is a sample of resolutions proposed by Republican lawmakers in the past few weeks: Florida’s Ann Paulina Luna wants Congress to pass a law adding Trump’s likeness to Mount Rushmore alongside presidents such as George Washington and Abraham Lincoln to reflect his “towering legacy”; New York’s Claudia Tenney proposes to make Trump’s June 14 birthday a federal holiday alongside Washington’s; a bill from Tennessee’s Andy Ogles would amend the US constitution to allow Trump to run for a third term so he has time to restore “America to greatness”. North Carolina’s Addison McDowell would rename Washington’s Dulles airport the Donald J Trump International Airport to thank him for the new “golden age of America”.
Who’s MIA?