US: Tax Cuts Boost Incomes, But Household Spending is Soft to Start 2018

Personal income rose 0.4% in January, beating the consensus expectation for a 0.3% gain. A reduction in current personal taxes led to an even more sizable gain in disposable income, which rose 0.9% on the month. Controlling for inflation, real disposable income was up a robust 0.6%.

Personal spending came in on expectations, rising 0.2% in nominal terms. In real (inflation-adjusted) terms however, spending fell 0.1%. By component, real spending on durable goods declined 1.6%, pulling back after a strong 0.6% (but downwardly revised) gain in December. Non-durable goods spending was flat, while services spending edged up 0.1%.

Prices rose 0.4% month-on-month in January, as energy prices rebounded (+3.0%). Headline inflation was unchanged at 1.7% year-on-year. Core prices firmed, rising 0.3% (m/m) in January, but core inflation remained unchanged at 1.5% year-on-year.

The personal saving rate jumped to 3.2% from an upwardly revised reading of 2.5% in December, as households held on to some of their windfall gains from lower taxes.

Key Implications

Just as it did at the beginning of 2016 and 2017, consumer spending started the year on a soft note. This despite the boost to disposable income from a smaller tax take. Some of the spending weakness is simply give back following hurricane-induced buying late in 2017. Nonetheless, it is difficult not to notice the apparent seasonal pattern even in the “seasonally adjusted data,” whereby relatively strong gains in December are followed by a pullback in January.

The weakness to start the year is likely to imply a relatively slow first quarter in terms of real GDP growth. Even with relatively strong growth in February and March, both real consumption and GDP appear likely to have a one-handle in front of them. Still, we are not concerned with the apparent setback, which is likely to prove short lived. With both tax cuts and a tightening labor market likely to push up income, household demand is expected to accelerate enough to pull growth to an above-trend rate over the remainder of 2018.

While inflation remained unchanged on a year-on-year basis, the momentum has picked up in recent months. The annualized three-month moving average inflation rate currently sits at the Fed’s 2.0% target. Still, there is cause to fade some of this strength – the residual seasonality in the real spending data is the flip side of seasonality on the inflation front, where price growth appears understated at the end of the calendar year and overstated in January.