Consumption is Driving Rates

Understanding Consumption and GDP 

Consumption is the purchasing and use of goods and services by households to satisfy needs and wants. It is important because 68% of Gross Domestic Product (GDP) is based on consumption.   

GDP is the dollar value of all goods and services produced in our country. It is the chief measure of economic health of a nation. A recession (bad economy) is usually defined as two (2) consecutive quarters of negative GDP (the economy is shrinking), so we can see that GDP really represents how our nation is doing.   

Understanding Recessions and Falling Interest Rates 

We have examined that interest rates decline during recessions, due to: 

• Investment dollars looking for safety in more stable investments that influence rates, and  

• Monetary policy from the Federal Reserve (Fed) that focuses on stimulating the economy (rate cuts and quantitative easing).  

Any report showing weakness in consumption will be an indicator to the market that rates are headed down.   

Key Reports Offering Consumption Clues 

This week we saw several economic reports that gave us clues to consumption.  These included:  

• Consumer Confidence, which infers that if you aren’t confident in your economic lot in life, you aren’t likely to spend 

• New and Pending Home Sales, which is important as one of the biggest spending events is buying a home 

• University of Michigan’s Consumer Sentiment, another measure of a consumer’s mindset towards their economic future and future spending 

• Personal Consumption Expenditures (PCE), the Fed’s favorite inflation measure that also contains important consumption data 

Consumer Confidence Report: Confidence Declines 

Consumer Confidence for March was released by the Conference Board and showed their index dropping to 92.9 from 100.1 in February. The higher the number the better the consumer outlook. This was the 4^th straight monthly decline.   

They also measure a sub-index for a consumer’s Present Situation and a consumer’s Expectations of the Future. Both saw drops too. The Expectations Index dropped to 65.2 and is at the lowest level in 12 years, and below the threshold of 80.0 that usually signals a recession ahead. 

University of Michigan Sentiment: Sharp Drop 

Like Consumer Confidence, the University of Michigan Index of Consumer Sentiment for March also dropped to 57.0 from February’s 64.6. Again, a higher score signals a better outlook.  

• The Expectations component has dropped more than 30% since November 2024.   

• All demographic and political affiliations had a clear consensus on worsening expectations for personal finances, business conditions, unemployment, and inflation. 

Atlanta Fed GDP Estimate: Stagnant Growth 

The Atlanta Fed released an updated Q1 2025 GDP estimate. It came in at 0.2% for the quarter. That is a very flat reading and isn’t surprising given the other economic reports.   

Comparing Inflation Reports: CPI vs. PCE 

The two important monthly inflation reports, Consumer Price Index (CPI) and Personal Consumption Expenditures (PCE), do have some important differences.   

Mortgage guru Rob Chrisman gave a quick analysis that is helpful to compare the two and to better understand why the Fed focuses on PCE: 

“CPI inflation generally runs about 0.4 percentage points higher than PCE inflation. The indexes are calculated using different mathematical processes.  

For example, the PCE formula adjusts its weights monthly, while the CPI does so yearly. When grocery shoppers switch to chicken after beef becomes more expensive, as we all would do, that change shows up in the PCE Index first. The PCE report includes purchases made by urban and rural consumers, while the CPI report only tracks spending in urban areas. The CPI includes only out-of-pocket spending made directly by consumers, while the PCE accounts for expenditures made on consumers’ behalf. For example, health insurance expenses made on behalf of employees by their employers or by Medicare and Medicaid are included in the PCE basket, not CPI.” 

PCE Inflation: Slightly Higher Than Expected 

PCE’s Headline Inflation for February rose, in line with expectations, by 0.3% and 2.5% YoY.  The Core rate that takes out volatile food and energy prices rose 0.4% in February and 2.8% YoY.  Markets were expecting 0.1% less on both.  

Shelter remains a culprit with its extreme lag in current market prices reflecting in the numbers. In addition, utilities, healthcare, and computer software all rose over expectations.   

Personal Spending and Income: Consumption Weakens 

Inside the PCE report we also see Personal Spending and Personal Income.  These are very important consumption indicators.   

Spending rose 0.4%, lower than the .5% expected and when combined with a 0.1% downward revision in February, made this a large miss.  Remember, consumers are laden with record levels of debt and shrinking savings.   

Private sector wages fell to 3.2% from 3.9% YoY.  As people make less, they spend less, and consumption shrinks, as does GDP.   

The Bottom Line 

These reports do sound negative for the economy, but the silver lining is rates improved this week and appear to have a good outlook in the future. 

Looking Ahead 

Next week is April, and also Jobs Week. Here are some key economic reports we’ll be keeping an eye on: 

Tuesday, April 1:  

• JOLTS (Job Opening and Labor Turnovers) 

• ISM Manufacturing 

Wednesday, April 2:  

• ADP Employment Report 

Thursday, April 3:  

• Initial Jobless Claims 

• ISM Services 

Friday, April 4:  

• BLS Jobs Report 

The Friday jobs report will be very important and will help give direction to the Fed for their May meeting.  Do they cut or hold rates?