The Federal Reserve’s preferred inflation gauge cooled as expected in January; however, the good news came with another potential red flag for the US economic engine: Consumers pulled back their spending by the most in nearly four years.
The Personal Consumption Expenditures price index rose 2.5% in January from the year before, slowing from December’s 2.6% annual rate, according to Commerce Department data released Friday.
Consumer spending was expected to drop off in January: There’s typically a post-holiday expenditure hangover to start the year; plus, last month’s retail sales data came in far below forecasts.
But consumers pulled back far more than economists expected: Spending fell 0.2% for the month. Adjusted for inflation, it sank 0.5%. Those are the biggest monthly declines since February 2021.
Spending on goods — particularly autos and other big-ticket items — dropped off the most, Friday’s data showed. Consumers continued to spend on the essentials, such as housing and gas, while also putting their discretionary dollars toward eating out and other leisure activities at hotels.
Consumers deciding to ‘sit it out and wait’
At first glance, January’s spending slump, the first negative monthly reading in nearly two years, appears to substantiate an increasingly unsettling picture of the economic outlook.
Not only do price pressures remain, but a slew of recent data indicates that the US economy is indeed softening: GDP growth is slowing, business investment has been sluggish, consumer sentiment has soured, jobless claims are picking up and inflation expectations are on the rise.
However, economists note that January’s slowdown in consumer spending also could reflect factors such as frigid weather, deadly wildfires, a natural retreat from goods splurges the months before, auto dealers cutting incentives after a blockbuster December and also just pure caution.
“Consumers are scrambling to process the winds of change coming out of Washington, and have apparently decided to sit it out and wait,” Christopher Rupkey, chief economist at FwdBonds, wrote in a note to investors on Friday.
To be sure, as incomes shot higher in January (rising 0.9%), consumers socked those dollars away instead of spending. The personal saving rate skyrocketed in January, jumping to 4.6% from 3.5%, Friday’s report showed.
“Spending was much lower than expected; however, it came after pretty strong readings in the prior months — partly tied to holiday spending as well as the rebuild from the hurricanes that happened in October and September,” Beth Ann Bovino, US Bank’s chief economist, told CNN in an interview.
To that end, Bovino and others anticipate there could be a rebound in spending in the coming months, considering the labor market remains solid and as the Los Angeles area rebuilds from devastating wildfires.
“Beyond the dramatic drop in spending that could be explained as temporary, the report had good news on inflation and excellent news on income,” Robert Frick, corporate economist at Navy Federal Credit Union, wrote in commentary Friday. “Spending tends to follow income, and while consumers are jittery as evidenced by recent weak consumer sentiment and consumer confidence measures, if people have money, they usually spend it.”
Inching closer to 2%
Excluding food and energy prices, which tend to be more volatile, the closely watched core PCE price index rose 0.3% for the month and 2.6% from a year before, slowing from 2.9% in December.
The cost of food (especially eggs) and energy pushed up the Consumer Price Index and Producer Price Index readings for January. That had economists expecting PCE would rise about 0.3% from December but that the annual rate would slow to 2.5% from the initially reported 2.6%, FactSet estimates show.
“The good news from this report is that inflation didn’t come in hotter than we, and looks like markets, expected,” Bovino said. “We don’t think that cooler reading is going to change the Fed’s path, given a lot of uncertainty over inflationary White House policies; but it does reduce the risk of fewer cuts.”
Friday’s reading puts inflation back within striking distance of the Fed’s 2% target and indicates that some disinflationary trends are still in play.
However, close only counts in horseshoes and hand grenades.
The Fed itself indicated that it could take until 2027 for the pace of price hikes to stabilize at that 2% level.
It’s widely expected that the Fed will hold rates steady when policymakers meet in March. Given the latest inflation read, Bovino anticipates that the next cut could come in the summertime.
Sen. Elizabeth Warren, a Democrat from Massachusetts, on Friday raised alarm about the potential negative ramifications if the Fed does not move to cut rates.
“With flashing warning signs — dissipating labor gains, declining investment, and falling consumer confidence — today’s inflation data shows that the Fed has a small window to act to cut interest rates,” she said, categorizing the Trump administration’s policies as creating a “chaos economy.”
“At its meeting next month, the Fed should modestly cut rates to provide a buffer to respond to future uncertainty,” she wrote.
Prices remain elevated, and the cumulative effects of high inflation and high interest rates continue to weigh heavily on Americans, especially those who have little wiggle room in their monthly budgets. As of December 2024, prices were 10% higher than their pre-pandemic trend, new data from the Federal Reserve Bank of St. Louis shows.
Soft signals about the economy
The pullback in spending comes at a time when American consumers are growing increasingly pessimistic on fears that inflation will pick up because of President Donald Trump’s talk of wide-ranging tariffs, according to various surveys.
Trump has floated reciprocal tariffs on America’s trading partners and 25% duties on Mexico and Canada as well as an additional 10% tariff on Chinese goods.
The University of Michigan’s February consumer survey showed that long-run inflation expectations surged to their highest level in nearly three decades.
The concern with higher inflation expectations is that they can be self-fulfilling to some extent: If consumers anticipate that prices will remain high, they might pull the trigger on large purchases and demand higher wages, and businesses might raise prices in response.
Recent data has indicated shifts in purchases made by consumers and businesses — likely tied to uncertainty around tariffs.
Fed officials have expressed in recent speeches that it’s crucial for people to keep faith that inflation will eventually return to normal in the long run.
While uncertainty has swelled in part because of the shock-and-awe policy moves from the Trump administration, it remains to be seen how actions such as steep and broad tariffs, mass deportations, and the shrinking of the federal workforce could affect the broader economy.
Comerica’s Bill Adams noted that the consumer spending drop and the jump in the trade deficit could end up weighing on real GDP growth in the first quarter.
“The question is the extent to which they are one-offs,” he wrote in commentary. “Import growth will likely be strong in February as well, as companies race to get ahead of decisions on tariff increases. But like January’s drop in consumer spending, this is probably a temporary drag on GDP, since much of these imports will be companies pulling forward purchases that they otherwise would have made later in the year.”
