Decoding America's Economic Pulse: A Deep Dive into Inflation, Consumer Sentiment, and Spending Patterns

Two-thirds of the U.S. GDP is comprised of household consumption. To comprehensively understand the U.S. economic situation, it's crucial to examine various inflation indicators and consumer sentiment together. As we approach the release of the U.S. Consumer Index this week, this analysis will take a holistic look at the PCE price index, discretionary/non-discretionary inflation, and the University of Michigan's Consumer Sentiment Index.

1.PCE/Core PCE Price Index Trends

(Data Source: FRED, Federal Reserve Bank of St. Louis)

The PCE index and core PCE index generally show similar patterns, but there are important differences. Core PCE tends to show a more stable trend as it excludes volatile food and energy prices.

• 2020-2021: Both indices rose sharply after the COVID-19 pandemic

• Mid-2022: PCE index recorded higher levels than core PCE

• Recent: Both indices are on a downward trend, but still above the Fed's 2% target (Latest data: PCE 2.51%, Core PCE 2.63%)

2. Discretionary vs. Non-discretionary Inflation

Discretionary goods are non-essential items consumers can forgo based on their financial circumstances, such as luxury vacations, fine dining, or high-end electronics. In contrast, non-discretionary goods are necessities crucial for daily living, including basic food, healthcare, housing, and transportation. The distinction lies in the consumer's ability to adjust spending on discretionary items during economic hardships, while non-discretionary expenses remain relatively constant. As shown in the graph above, there are clear differences between discretionary and non-discretionary inflation.

Non-discretionary inflation is generally higher and more volatile. This is because non-discretionary goods have low price elasticity, meaning consumption cannot be reduced even if prices rise, and inflation is directly reflected when prices increase. Additionally, it is heavily influenced by volatile commodity, energy, and agricultural prices, exposing its volatility.

• Recently, discretionary inflation (1.1%) is much lower than non-discretionary inflation (3.7%)

• Increased cost of living: Higher non-discretionary prices increase the burden of essential spending

• Changes in consumption patterns: Potential decrease in discretionary spending (travel, dining out, expensive durable goods, etc.)

• Changes in savings rate: Concerns about reduced savings capacity due to increased essential spending

• Widening income inequality: Lower-income groups are disproportionately affected

3.Analysis of the Michigan Consumer Sentiment Index

The University of Michigan's Consumer Sentiment Index is an important indicator of U.S. consumers' perceptions and expectations of the economy. Analyzing the recent graph reveals the following characteristics:

• COVID-19 pandemic shock and recovery: Sharp decline in early 2020, followed by recovery until mid-2021

• Downward trend in 2022: Dropped to historic lows around 50 in mid-2022, mainly due to high inflation and supply chain issues

• Recent trends: Gradual recovery from 2023, rising to 80 in early 2024. However, it has recently fallen again to 68.20, indicating persistent economic uncertainty

• Generally, consumer sentiment tends to deteriorate when inflation is high

4.Economic Outlook and Implications

• Expected changes in consumer behavior: Declining consumer sentiment may lead to reduced consumption, especially in discretionary spending (travel, expensive durable goods, etc.)

• Impact on businesses: Potential negative impact on sales and profit forecasts for consumer goods companies. Expected widening performance gap between essential and non-essential consumer goods companies

• Monetary policy implications: The Fed faces the challenging task of curbing inflation while preventing economic recession. Weakening consumer sentiment could put pressure on future interest rate cuts

• Investment strategy: Potential increased preference for defensive sectors (essential consumer goods, utilities, etc.). Need to monitor fund movement to cyclical sectors when consumer sentiment recovers

Conclusion

U.S. inflation trends and consumer sentiment are closely related, and recent data reflects the complex economic reality. Despite various price indices showing some stabilization trends, non-discretionary inflation remains stubbornly high at 3.7%. This, coupled with the recent decline in consumer sentiment, underscores the ongoing economic challenges and suggests persistent uncertainty about the current state of the economy. It will be necessary to adjust portfolios considering sector-specific impacts while monitoring changes in these price indicators.