Market Review: Personal Income & Expenditures – PCE Deflator

The Fed’s favorite inflation indicator, the PCE Deflator, just printed its highest reading in 40 years. Personal incomes & expenditures printed this morning with advances there. However, the real headline came from PCE Deflator which came in at 6.59%[1]Bureau of Economic Analysis (BEA) for PCE Year-Over-Year Change, the highest reading in many years. Inflation fears, or course, have been driving the markets and for the month the Dow dropped 9.5% making April the worst month in two years.

I believe that we will start to see moderation over the next couple of months since the year-over-year change is driven by the stimulus checks received last year.  Now that those funds have been spent, spending will decrease accordingly, and prices pressures will abate.

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Personal Incomes & Expenditures

Personal income, on a year-over-year basis, is down sharply after the spike higher from stimulus checks
On a year-over-year basis, personal income is down sharply when compared to the surge from stimulus checks

On a Year-Over-Year basis, personal incomes & expenditures, are both transitioning from the stimulus income received over the past two years. Not all checks were received all at once and took time to process. This income was extraordinary and out of the norm of previous data points. This created a surge in both income & expenditures. Because of that, data points the following year are lower; they are more appropriately aligned with normal incomes and expenditures.

Personal Consumption Expenditures is declining since stimulus checks were received
Expenditures, seeing a sharp fall after the initial lockdown, spiked aggressively after stimulus checks were delivered. Now, expenditures are moderating back toward normal

The chars show this decrease from the previous period. Now, despite normalized numbers, the charts are distorted.

Looking at the initial drop in expenditures at the beginning of the lockdown, you can then track the big spike upward after stimulus checks were delivered.  Now, incomes are moving back toward more appropriate levels.  And, consumption will follow given the strong correlation between incomes & consumption.

PCE Deflator

Personal Consumption Expenditures PCE Deflator rose sharply on a Year-Over-year basis showing inflation concerns

First, what is the PCE Deflator? The PCE Deflator is the inflation gauge inside personal incomes. As you can see from the charts, there has been a tremendous surge from expenditures driven by the stimulus checks. One important point is that the numbers above are Year-Over-Year changes. And, the data points come after the big stimulus checks were received.

When you think this through, inflation coming from big surges in expenditures makes a lot of sense. All at once, Americans received checks. Then, all at once, the spent the funds. This cleared out inventories from businesses. That drove companies to order fresh inventories. But, this was nearly every business pushing for new inventories. And, China as well as the rest of the world, were in a severe lockdown. Production was hampered on many levels. With more and more businesses competing for limited resources, this drone prices higher.

But, the stimulus money has all been spent. Look for a relaxing of prices as inventories begin to get restocked, even for raw, unfinished goods.

Interest Rate Outlook & PCE Deflator

US Oil Benchmark: Image showing price movement prior to SPR release of 1 million barrels of oil per day for 180 days
Significant supply is about to hit the market with the SPR releasing 1M barrels of oil per day for 180 days

Another thing I keep an active eye toward is the price of oil. Oil has shot up because of supply concerns with Russia’s invasion of Ukraine, and the subsequent embargo of Russian oil.

Oil production is going to increase significantly over the course of the remainder of this year. First, the United States is at its peak with the number of oil rigs operational at this time. That will drive supplies upward.

Simultaneously, starting in May, and running for 180 days, the Strategic Petroleum Reserve (SPR) is going to be dumping 1 million barrels of oil into the market place. This is exactly the reason the SPR exists; to alleviate oil supply shocks until the marketplace can adjust and ramp up production. Sales of oil from the SPR, along with increased production, will add even more oil into the system which will drive price lower.

Stock Market & PCE Deflator

SPX 500
The stock market had its worst month in two years amid inflation fears. I expect inflation to moderate in the coming months; albeit, interest rates are still going higher

My expectation is that the big surge that was driven by the stimulus checks will now see changes in growth rates, on a year-over-year basis, will move back toward normal. This will help to temper fears fo interest rate increases.  And, the stock market is likely to begin its move higher despite interest rate increases.  But, I also expect the progression higher in stocks will be at a lower rate than what has been seen over the past two years.

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Forward look: PCE Deflator and interest rates

US 10-Year Yields during inflationary concerns as the 10-Year moves higher

One thing to keep in mind is that more and more Americans are commuting to work agains as the WFH phase is ending. This means paying for gasoline instead of “Fill to Cart” buttons being pressed en masse. While Americans will still be spending their income, more and more it will be going toward filling their gas tanks versus Amazon shopping carts. And, with the price of gasoline near all-time highs, this acts as a tax on incomes.

Combine the fact that now Americans have to pay for their Fill to Cart addiction the racked up on their credit cards, higher interest rates are going to mean higher payments. Again, this will act as a consumption tax on the economy.

I can easily see a moderation in inflation over the next several months. So, while the headline number was eye-popping, it is also very likely transitory and near the highs it will be at.

Federal Reserve Meeting

The Federal Reserve meets on Tuesday & Wednesday of this week to determine interest rates. This meeting is a foregone conclusion: Interest rates are going up by 50 basis points. But, we are on the lookout for the statement after the fact.

I can expect a bit of noise in the markets this week. But, after the meeting, assuming we do not get a statement that is far too hawkish, stocks will head higher.


1 Bureau of Economic Analysis (BEA) for PCE Year-Over-Year Change

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