Inflation surprisingly rose in January, according to the Fed's preferred gauge
The Federal Reserve's preferred inflation gauge heated up unexpectedly in January, as did consumer spending, showing the continued strength of the US economy — and that rising prices won't be so easily defeated.
Inflation picked up speed in January as the Personal Consumption Expenditures price index rose 5.4% in January from a year earlier, the Commerce Department's Bureau of Economic Analysis reported Friday. In December, prices rose 5.3% annually.
In January alone, prices were up 0.6% from the prior month, a higher monthly gain from December's increase of 0.2%.
Some welcome news: Goods prices continued falling, declining 0.7% from the previous month. But services prices increased 0.5%.
The Fed's go-to inflation gauge, the Core PCE Index (which strips out the often volatile food and energy categories) showed prices rising 0.6% on a monthly basis and 4.7% for the 12 months ending in January.
That's a fair share hotter than what economists were expecting. Consensus estimates on Refinitiv projected the annual core index to land at 4.3% and extend what was a three-month stretch of cooling.
President Joe Biden said the higher-than-expected reading shows that the country has "more work to do" but lauded the progress the economy has made during his administration.
"Annual inflation in January is down from the summer, while the unemployment rate has remained at or near a 50-year low and take-home pay has gone up," Biden said in a statement issued Friday. "As I've long said, there may be setbacks along the way, but we face global economic challenges from a position of strength."
The PCE indexes are included in the Personal Income and Outlays report published by the BEA. The report includes the latest estimates on how much consumers are bringing in and how much they're spending.
Consumer spending and personal incomes rose 1.8% and 0.6% last month, respectively, according to the report. Consumers also put more in their piggy banks: the personal savings rate increased 0.2 percentage points to 4.7% in January.
"It seems like consumers were feeling jolly in January," Gregory Daco, EY Parthenon chief economist, told CNN Business in an interview. "They spent more freely across the board, really on all items, despite inflation being higher."
Stocks plunged on Friday morning as the PCE report's numbers support recent data that shows inflation isn't falling at the pace investors had been hoping. It also adds pressure on the Fed to continue with its rate-hiking campaign for longer than markets anticipated just a few weeks ago.
The Dow was down 364 points, or 1.1%, on Friday morning. The S&P 500 fell by 1.2%, and The Nasdaq Composite was 1.7% lower.
All major indexes are heading for a losing week. The S&P 500 is down 1.6% and is set for its worst week since December 16. The Dow is down nearly 2% and headed for its fourth straight losing week. The Nasdaq, meanwhile, is down 1.7%.
Not what the Fed wants to see
Any uptick in inflation is the exact opposite of what the Fed wants to see, Daco added.
For the past year, the Fed has undertaken a heavy-handed approach to try to cool down decades-high inflation by cranking up interest rates in order to stifle demand.
"We are likely to experience surprises in this disinflationary process, it's not just going to be a smooth ride back down to the low levels," Daco said. "And so we'll have to see whether the Fed panics in light of this recent report."
Earlier this month, Fed Chair Jerome Powell cautioned that the inflation fight would take a 'significant period of time' and that the central bank would likely keep interest rates higher for longer.
Part of the challenge, economists and Fed officials say, has been some of the unique factors playing into this recent stretch of high inflation, including the global pandemic and its drastic effect on the US economy, labor market, supply chains and spending patterns; influence of stimulus efforts to keep the economy afloat; and geopolitical shocks.
Additionally, while monetary policy does act on a lag, the rapid increase in interest rates have filtered down to some areas of the economy, notably housing and financing.
However, the labor market has remained extremely tight and employment gains strong — January's report showed a blowout 517,000 jobs added. The continued robustness stands somewhat at odds with the Fed's efforts, as ongoing labor shortages continue to keep upward pressure on wages.
The resilient consumer's spending surge
The spending increase was to be expected — the Commerce Department's stronger-than-expected retail sales report for January gave an early indication that Americans' loosened the purse strings after a reined-in holiday shopping season — but the pace in Friday's report surprised on the upside as well and exceeded economists' forecasts of a 1.3% gain.
Spending on durable goods (items like cars, appliances and TVs expected to last three or more years) increased 5.5% last month, buoyed by vehicle sales; non-durable goods (clothing, gas, groceries, etc.) increased 1.2%; and services gained 1.3%, according to the report.
Economists have suggested that the January spending surge may reflect a variety of factors including warm weather, a rebound of muted holiday spending, seasonal data adjustments, first-of-the-year boosts in Social Security income and state minimum wage increases, and a strong and tight labor market.
"I think we can't just try and make excuses for the consumer: The consumer is more resilient than initially thought, and households are still spending relatively freely as of January," Daco said.
However, given the high inflationary environment, rising interest rates, and the latest household debt data that shows some deterioration in Americans' finances, the spending gains seen in January may not be lasting, he added.
Consumer sentiment picks up in February
Still, even through most of February, consumers are feeling more upbeat about the current and future direction of the economy, according to a closely watched survey released Friday by the University of Michigan
The university's final consumer sentiment index for February measured 67.0, a higher reading than preliminary estimates released earlier in the month as well as January's 64.9.
Economists were expecting the headline consumer sentiment index to read 66.4, according to Refinitiv.
The sentiment index, which has risen for three consecutive months, is now 17 points above the all-time low in June 2022, according to Joanne Hsu, director of the University of Michigan's Surveys of Consumers.
"Consumers have noted both positive and negative developments in the economy," Hsu said in a statement. "On one hand, worries about rising unemployment have emerged for some amid layoff announcements. On the other hand, labor markets continue to enjoy historic strength, supporting robust income growth. Consumers will weigh the balance of factors, focusing on implications for their own budgets, as they make decisions on spending or saving."
Still, consumers also believe inflation will be higher in the near-term.
Year-ahead inflation expectations bounced back up, coming in at 4.1% this month. That's an increase from 3.9% in January and down from December's 4.4%. Long-run expectations for inflation held pat at 2.9% for the third consecutive month, according to the report.
Inflation expectations are crucial data points for the Federal Reserve. If consumers believe prices will remain high, that could factor in to increased wage demands, which could cause businesses to raise prices.