Consumption – how does it affect inflation outlook?
Macro Insight
QuantCube explores three possible scenarios for US economic outlook
The U.S. economic activity is mainly driven by private consumption – it currently represents approximately 70% of GDP. As the speculation mounts on a slowing economic recovery, consumption is back under scrutiny. It also sheds an interesting light on the possible causes of higher inflation, which itself is the subject of growing concerns.
QuantCube developed its Personal Consumption Expenditures (PCE) Index using multiple alternative data sources and proprietary algorithms (due to launch soon). The real-time indicator is primarily demand-oriented and independently tracks the main sectors of U.S. consumption. Sectorial indicators are then aggregated to follow the headline PCE in real-time.
The breakdown between goods and services in these main sectors of U.S. consumption shows two very different trajectories during the 2020 crisis, as Exhibit 1 indicates. Goods consumption, as nowcasted by QuantCube’s PCE Index, quickly bounced back after the significant drop in March-April 2020 and then recovered further to exceed its pre-pandemic trend significantly.
On the other hand, the recovery trajectory was not the same for services consumption, which also dropped sharply at the beginning of the pandemic. Its recovery in QuantCube’s PCE Index was slower, and it continued to lag its trend except for a few months of spike in mid-2021. This spike caused by the acceleration of the vaccination program and the persistence of bases effects in our index quickly faded.
Our real-time data showed a higher demand in goods, in particular, in durable goods. This higher demand was the driving force for the economic recovery, but it also fuelled a shipping and supply-chain disruption as we explained in our previous newsletter. The unexpected spike in goods demand also explains the uptick in inflation, demand in durable goods significantly exceeded supply, leading prices to rise significantly as a result. This is still the case today - prices in durable goods are the second most important driver in the current price increase after energy products. As Exhibit 2 indicates, inflation in durable goods currently appears higher than inflation in services – a situation we haven’t seen in the US since the mid-1990s. Using QuantCube’s consumption and inflation indicators we can monitor this unusual condition in real-time effectively.
Consumption and Inflation Outlook
QuantCube’s indices provide valuable insights into the health of the economy in real-time, therefore, we are able to share a more precise outlook for Q4 2021. Based on our latest data, we observe a continuation of the condition seen in the last months; demand for services partly recovered to below its pre-pandemic trend, while demand for goods remains significantly above its trend. Three scenarios could emerge for consumption outlook in the near future:
Should such a regime continue, CPI inflation may stabilize to a level lower than today’s 6.2%, but higher than the Federal Reserve’s inflation target (2.0%) due to the inflationary pressure created by high goods demand.
An unexpected drop in demand would have different effects on macroeconomic condition depending on the sectors experiencing the particular decline. Although a drop in goods demand would be concerning for the US economy with potential for a serious slowdown, it would most likely put a lid on inflationary pressure. Similarly, a drop in service demand would also influence a potential growth slowdown, but its effect on inflation is likely to be limited in our view.
A rising demand would fuel the fears over an overheating US economy. In this scenario, services demand catches up on goods demand or the latter rises even further. Such a situation would cause a concern over an overheating of the US economy, and, therefore, it may lead to inflation well above the 2.0% level.
At a time of uncertainty predicting the course of macroeconomic conditions becomes challenging. It is therefore particularly important to observe underlying conditions in real-time rather than relying on lagging official numbers. Together with QuantCube’s US Inflation index, our new consumption nowcasting index will help investors monitor the risks of high demand on future inflation. The reverse is also true; lasting inflation could affect consumption by cutting into consumers’ residual income. Using QuantCube’s consumption index, investors will be able to determine which sectors are most or least affected in real-time.
Other interesting indicators linked to this topic include our nowcasting of the US GDP and various shipping and supply-chain related indicators. The latest numbers of these indicators are all available on QuantCube Macroeconomic Intelligence Platform (MIP).
