Consumer Data Proving Fed Right on Inflation

Maybe those Federal Reserve economists know what they’re talking about, after all.

For months Fed policy makers – namely Fed Chair Janet Yellen – have told us that a tightening job market will lift wages and push consumer spending higher. And when that happens inflation will start edging upwards toward the Fed’s 2% target.

Based on that forecast (among other things) the Fed raised interest rates last week for the first time in nearly a decade, moving U.S. monetary policy away once and for all from the easy-money era initiated in the wake of the 2008 financial crisis.

Evidence of that rising wages/rising inflation scenario becoming a reality was offered in the November personal income data released Wednesday by the Commerce Department. The report showed that personal income of American workers rose for the eighth straight month due to rising wages.

According to the report, income increased 0.3% last month after an unrevised 0.4% rise in October. Economists polled by Reuters had forecast income advancing 0.2% in November. Wages and salaries rose 0.5%, adding to a 0.6% gain in October.

Economists believe the momentum will continue into the new year, with rising wages fueling stronger consumer spending.

“The consumer spending outlook for the next couple of years is looking better than in 2014, premised on continuing strength in real disposable income growth, further strength in auto sales, increasing household real estate wealth, and modest consumer price inflation. The positives clearly outweigh the negatives on the consumer front for 2016; however Americans have not thrown caution to the wind,” said Chris Christopher Jr., director of consumer economics for IHS Global Insight.

Consumer spending, which represents more than two-thirds of U.S. economic activity, rose 0.3% in November when adjusted for inflation after holding steady in October.

While fourth-quarter consumer spending is apparently failing to keep pace with last quarter’s strong 3% pace, November's solid showing could prompt economists to modestly lift their fourth-quarter gross domestic product estimates.

GDP growth estimates for the final three months of the year have been hovering around a 2% rate, the same pace of growth in the third quarter.

As the focus now shifts away from the timing of the first rate hike to the path of interest rates moving forward in 2016, a great deal more attention will be paid to the trajectory of inflation.

Last week, citing a stronger jobs market and “confidence” that inflation will be ticking higher, the Fed raised rates by 0.25% to a range of 0.25%-0.50% from the near-zero range where they’d been held since December 2008.

A primary reason the Fed held interest rates at a near-zero range for as long as they did was because inflation remained stubbornly low despite a strengthening jobs market. And the reason inflation was held down was because wages weren’t rising in tandem with the momentum in the labor market.

But that appears to be changing, as the two most recent jobs reports from October and November revealed that wages were starting to edge higher, numbers confirmed Wednesday by the Commerce Department numbers.