U.S Economy: Washington Joins Wall Street Fighting The Fed With Fiscal Easing

These days, Wall Street headlines on the U.S. economy are all inflation numbers, substantial job gains, robust retail sales, and persistent income and consumer spending growth. They all tell a story of an economy defiant of the Fed's interest rate hikes, disappointing traders and investors who bet on the nation's central bank would have managed to cool the economy by now and bring inflation under control.

For instance, the Fed's most favored inflation gauge, the Personal Consumption Expenditures (PCE) price Index rose 0.6% m/m in January, pushing the annual rate to 5.4%, up from December's 5.3%. In addition, the core PCE rate, which excludes the volatile food and energy prices from the calculations, rose at an annual rate of 4.7%, ahead of Wall Street's expectations of 4.4%.

The high PCE inflation number follows two other numbers, the Consumer Price Index (CPI) and the Producer Price Index (PPI). They, too, confirmed that inflation remains elevated.

Meanwhile, other data on the labor market, retail sales, and personal income and spending confirm that the U.S. economy continues to grow, supporting and re-enforcing one of the critical drivers of inflation: demand for goods and services beyond the economy's capacity to accommodate it.

The headlines of a strong economy helping keep inflation numbers stubbornly high dashed Wall Street's expectations of a quick end to the Fed's interest rates hikes.

"With inflation running much higher than the Federal Open Market Committee would like, PNC expects the committee will raise the fed funds rate by 25 basis points at each of its next two meetings, in mid-March and early May," Gus Faucher, Chief Economist at PNC Financial Services told International Business Times. "With further monetary tightening coming, PNC expects a mild U.S. recession in the second half of this year."

Thus, the wild ride seen on both the debt and equity markets during the week.

"It was another difficult week for the market," Paul Kutasovic, Professor of Finance, told IBT. "The PCE shows little progress the Fed has made in fighting inflation over the last few months.

Nonetheless, Professor Kutasovic points to a couple of numbers Wall Street headlines missed, suggesting that the recent strength of the U.S. economy may be an aberration due to one-time factors rather than an undergoing trend.

"On the income and spending, we saw a big surge in Consumption but driven by a 5.2% increase in durables (main autos) which is not likely to be repeated," he explained. "Income growth was weaker than expected, but the big news was the upward revisions to income. BEA revised income by $85 billion and $108 billion in the third and fourth quarters, respectively, while the saving rate in January was 4.7%. So the bottom line is consumers still have more gas in the tank."

He sees the economy slowing in the months ahead, with a downward revision of the 4th quarter GDP in the cards. "Most of the growth was in inventory building, government spending, and net exports," he explained. "Growth in core GDP was around zero. Net exports improved since imports declined sharply, not a positive development. Also, look at the weekly indicators from N.Y. Fed, which confirm that economic growth has already stalled."

Dan North, Senior Economist at Allianz Trade, provides further insight on the strength of personal income and consumer spending and savings data.

"A more meaningful measure of what consumers can spend is Real Disposable Personal Income (DPI) which strips out inflation and taxes," he told IBT. "In January, real DPI rose by 1.4% m/m to 2.8% y/y, again boosted by that 9% increase in Social Security payments. The m/m and the y/y rates were the highest since the cash injection from the American Rescue Plan (ARP) in March of 2021."

But there's another unusual factor boosting household financials, personal taxes. It dropped by a record amount of -$256 B; the previous record was -$178.

"That contributed to the 2.8% increase in real DPI. But it's unclear where that tax cut came from – there's not a whisper in the BEA's report," North added.

"Real consumer spending (PCE) rose 1.1% m/m, which was the highest since.. you guessed it… the ARP," North continued. "The y/y rate rose to 2.4%, but that's still less than the long-term average of 3.2%, and the trend over the past year is still down. Perhaps the 9% Social Security boost increased income and consumption numbers."

Simply put, it may not be just Wall Street fighting the Fed. It's Washington, too, with fiscal easing.

"So just looking at the inflation numbers, the Fed surely has the green light. But it is better to look carefully at those income and spending numbers. With the Social Security boost and the record drop in taxes (does Janet Yellen know about this?), the economy's strength is a little less clear," concludes North.