New data on U.S. Personal Income and Outlays in February showed both holding fairly steady. That’s consistent with the trend of the last year and a half, when the mayhem of Covid’s onset gave way to more stable consumption growth.

In Focus - Restoring Stability

It’s easy to fall prey to the allure of month-to-month changes in key economic statistics. Markets do it with troubling regularity. Take real personal consumption expenditures (PCE). In February, PCE fell by just 0.1%; real disposable personal income (DPI) rose by just 0.2%. There are good reasons to focus on personal consumption, since in 2022 it accounted for 70.6% of U.S. real GDP.

That makes it all the more important to be cautious about reading much into these small monthly moves. First, they require context. Second, they are subject to revision. As an example of both, last month we were told that real PCE had risen by 1.1% in January. This month’s release revised that to 1.5%, meaning the newly-reported February drop was actually swamped by the January upward revision.

This week’s chart is an attempt to provide a longer-term perspective. It shows real PCE (black) and DPI (red) over the last five years, indexed to August 2021 (in levels, DPI is higher than PCE). It also breaks down PCE into goods and services sub-components. One could argue that there are three distinct eras:

1. Pre-Covid (to February 2020)
2. Covid Mayhem (March 2020-July 2021)
3. Stability Restored (August 2021-present)

This is clearest for the PCE line, which is relatively smooth in Era 1, takes a sharp, craggy dip in Era 2, then seems to pick up where it left off in Era 3.

DPI, in contrast, spikes upward during the Covid Mayhem. It is relatively stable in the third Era, though it has a notable dip and recovery. While not in the chart, the personal savings rate has been steadily rising across this third era, from a low of 2.7% in June 2022 to 4.6% in the February release. Both DPI and the savings rate help indicate whether continued consumption is affordable.

The relative stability of the third era does not mean that everything is back to pre-Covid norms. Note that services consumption (the dashed line) has recovered its earlier levels, but does not appear to be back on its pre-Covid trend. Goods consumption emerged from the intense volatility of Covid Mayhem at a notably elevated level (without indexing, services consumption is substantially higher than goods consumption).

If we accept that this third era involves steadier growth in consumption, is that good or bad? While less frantic than the second era, it nevertheless raises some potential issues. First, real goods consumption rose at an 11.9% rate from March 2020 to July 2021, but only 1.3% since August 2021. The latter figure is positive, but dramatically lower. If a business had been planning for the rapid growth to continue, it could easily get caught with overflowing inventories.

Second, while the Covid Mayhem Era brought accelerating inflation, the third era has featured sufficiently strong consumption and growth that inflation has remained well above the 2% target level set by the Fed.
Working that inflation out of the economy may require yet a fourth era in which the economy slows notably.

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From last week: In Focus - Trade Finance: Ill Winds Blowing?. We look at headwinds in trade finance.

Economic Developments

The trimmed-mean PCE inflation rate was 4.6% for the 12-month period ending February, unchanged from the January reading. The core PCE inflation rate, which strips out food and energy, was also 4.6% for the month, down only 0.1% from January. Trimmed-mean PCE is a measure of prices weighted to account for changes in consumer spending patterns (see essay above). Markets on Friday seemed to find cause for optimism in the core PCE reading.

The flash estimate for headline annual inflation in the Euro Area in March was 6.9%, a fall of 1.6 percentage points from February. Energy prices, which had been rising but at a slowing rate, actually decreased by 0.9%. However, core inflation rose 0.1% over the previous month to reach a 22-year high of 5.7%.

The unemployment rate in the Euro Area, meanwhile, was 6.6% for February on a seasonally-adjusted basis, the same as it had been in January and below the 6.8% figure from a year earlier. Greece and Spain, in particular, continue to see high levels of unemployment, at 11.4% and 12.8%, respectively, while labor markets remain tight in Northern Europe – Germany’s rate remained at 2.9% and the Netherlands fell by one-tenth of a percentage point to 3.5%.

U.S. inventories, adjusted for seasonality but not prices, were up 0.2% at the wholesale level and 0.8% at retail month-on-month in February. Year-on-year retail inventories ex-autos were 7.3% higher, however, while wholesale inventories of durable goods were 15.6% higher.

South Korean trade figures for March showed exports down 17.4% year-on-year, the sixth straight month of declines. This was far a more dramatic fall than the previous month, when they came in at -7.5% by the same measure. As the first major economy to report monthly trade data, South Korean exports are watched as a bellwether for the state of global trade.

Political Developments

The OPEC+ group of oil producing countries will cut production by more than 1 million barrels a day, according to an announcement on Sunday. OPEC+ includes Russia, which is simply extending the 500,000 barrel/day production cut that it announced in March in response to price caps imposed on seaborne oil shipments. The surprise was Saudi Arabia’s ‘voluntary cut’ of the same volume.

The UK concluded its accession negotiations with the 11 current members to join the Comprehensive and Progressive Agreement for Trans-Pacific Partnership, or CPTPP, becoming the first country outside of APAC to do so. The UK government plans to formally sign the agreement this year, although no date has been given as of yet. The Department for International Trade estimates the UK’s accession will add 0.08% to its GDP over 15 years.

The U.S. and Japan signed an agreement on ‘strengthening critical materials supply chains’. The agreement covers five minerals used in the production of batteries for electric vehicles: cobalt, graphite, lithium, manganese and nickel. Once in effect, it will allow Japanese car manufacturers to benefit from EV subsidies contained in the US Inflation Reduction Act, per guidance issued by the Treasury last Friday. Talks on critical minerals are ongoing with the EU and for the same purpose.

Congressional leaders objected to a lack of consultation on trade policy, like the critical minerals deals and Treasury’s subsequent guidance on the IRA. The Ways & Means trade subcommittee chair called the actions ‘unconstitutional.’ The Chair of the Senate Finance Committee, along with the ranking member on Ways & Means also expressed concern about the ‘unilateral’ approach the White House is taking.

Japan announced export controls on advanced semiconductor equipment, following similar policy measures implemented by the U.S. last October aimed at China and Chinese firms. The Japanese policy, led by the Ministry of Economy, Trade and Industry, does not explicitly target any single country. The Netherlands, another major exporter of advanced semiconductor equipment, announced similar restrictions in early March, also without naming a specific country. Japan’s controls take effect from July.

The extent of U.S. - China decoupling is coming into focus, with new research showing goods imports from China down 25% in 2022 in the categories covered by the 25% tariffs first imposed during the Trump Administration and since left in place by the Biden Administration. These include semiconductors, IT hardware and select consumer electronics. Total goods imports from China, however, were up by 6% year-on-year, driven by goods that do not face these tariffs, which were up 42% compared to the period before the ‘Trade War’ started.

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