Price cuts by big U.S. retailers, as well as new statistics showing a slowing in consumer spending, may bolster the Federal Reserve’s confidence in decreasing inflation and dampen corporate earnings, which have taken a higher part of national income since the start of the COVID-19 pandemic.
Adjusted for inflation, both overall consumption and disposable income fell marginally in April. The Commerce Department reported on Thursday that the U.S. economy grew more slowly than expected in the first three months of the year, owing primarily to a slower pace of consumption, a key component of the economy that Fed officials believe must slow in order for inflation to return to the central bank’s target of 2%.

Inflation data issued on Friday indicated that the personal consumption expenditures price index increased at a 2.7% annual pace in April, mirroring the March gain. The Fed uses PCE inflation to determine its 2% inflation objective, while the “core” index, which excludes volatile food and energy prices, increased 2.8%, the same as the previous month.

Policymakers have expressed concern that progress toward the central bank’s inflation objective may have stagnated following a gradual fall from the peak above 7% in June 2022.

However, while the headline data indicated another lost month, there were signals of change. Core prices climbed less than projected month after month, and the dual reductions in “real” consumption and income reaffirmed the perception that the economy is gradually pulling back from a period of rapid expansion and price increases.
“While American household balance sheets remain solid in our opinion, the margin for discretionary spending has been much thinner,” said Tuan Nguyen, an economist at RSM US, echoing new data showing that spending on recreational goods has slowed as consumers spend more on housing and utilities.

Photo: Econlib

“More likely than not, the economy is cooling to a soft landing, giving the Fed reason to reconsider its aggressive approach of maintaining interest rates at a multi-decade high level… “If we see more data like this in the coming months, we believe the Fed should act sooner rather than later,” he wrote in an analysis of the new inflation and consumption report.
At its policy meeting on June 11-12, the US central bank is likely to maintain its benchmark interest rate in the 5.25%-5.50% range, where it has stood since last July. Fed officials said the next move on rates will most likely be to decrease them, but only when they are confident inflation will resume its slide to 2%.

Investors forecast an initial rate cut at the Fed’s September meeting, albeit by a narrow margin.
Policymakers have been hesitant to commit, stating that as long as the labor market and the economy as a whole remain solid, there is no rush to decrease interest rates, especially given the concerns they have about inflation.
Some policymakers, for example, have looked beyond the headline inflation rate to the percentage of goods and services whose price rises continue to surpass 3% each year. In April, that figure remained around 55%, nearly double what it was before the COVID-19 outbreak.

High-profile retailers such as Target (TGT.N) and Walmart (WMT.N) have been lowering food and other staple prices, with Walgreens (WBA.O) this week stating in a price-cut announcement that the company “understands our customers are under financial strain.”
Fed policymakers believe consumers are in generally excellent health, with unemployment low and earnings growing. However, they have identified symptoms of stress among lower-income households, such as growing loan default rates and credit card borrowing.
The price cuts announced this month may demonstrate a similar notion growing in company executive suites and sparking the sort of dynamic Fed policymakers had anticipated: A battle for market share as pandemic-era pricing power fades, along with the high profits that accompanied it.
The Commerce Department’s figures issued on Thursday revealed that, despite a minor drop in earnings, corporate profits continued to account for a larger share of total income received by individuals and firms.
Corporations’ share of revenue increased during the pandemic as tangled supply chains and pandemic-era transfer payments to individuals provided home-bound consumers with money to spend on items that had become scarce, resulting in price increases and bigger margins. When pandemic restrictions were lifted and in-person gatherings began, surplus spending power migrated to travel, restaurants, and other services, causing inflation to rise.
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Fed officials have stated in recent weeks that they believe the situation has evolved, with businesses generally reporting that their ability to raise prices is limited compared to the previous two years. In the Federal Reserve’s most recent “Beige Book” compilation of economic tales, there was a broad impression that customers were becoming more discriminating, putting pressure on enterprises.
“Consumers are growing more price-conscious, which will undoubtedly put pressure on profit margins. “We should expect more discounts and incentives as some consumers struggle with persistently high prices,” said Jeffrey Roach, chief economist at LPL Financial, following the release of the Fed study.