In a surprising turn of events, U.S. consumers drastically reduced their spending in January, marking the most significant drop since February 2021. According to a report released by the Commerce Department on Friday, consumer spending declined by 0.2% from the previous month. This downturn comes even as inflation showed signs of easing, but potential tariffs proposed by the White House could jeopardize this progress.
The decrease in consumer spending is likely influenced by several factors, including unseasonably cold weather. Yet, this reduction may also indicate a growing caution among consumers amidst rising economic uncertainty. Despite the decrease in spending, inflation fell to 2.5% in January compared to a year earlier, down from 2.6% in December. When excluding the more volatile categories of food and energy, core prices decreased to 2.6%, the lowest level observed since June, down from 2.9%.
One positive aspect of the report was the notable increase in incomes, which rose by 0.9% in January compared to December. This growth was significantly bolstered by a substantial annual cost of living adjustment for Social Security beneficiaries. The recent spike in inflation, which reached its highest rate in four decades in 2022, had propelled President Donald Trump to the White House and led the Federal Reserve to swiftly increase interest rates to combat rising prices. However, inflation has since declined from its peak of 7.2%.
The recent decline in inflation may offer some reassurance to Federal Reserve officials, indicating that inflation is gradually subsiding. The Fed tends to favor the inflation measure released on Friday over the more widely recognized consumer price index (CPI), which saw a consistent increase for the fourth consecutive month in January, rising to 3%. The Fed's measure calculates inflation differently, placing less emphasis on housing and used car costs.
Despite the positive signs in inflation, a significant concern looms over American consumers, investors, and business executives regarding Trump's extensive tariff proposals. On Thursday, Trump announced plans to double his recently announced tariffs on Chinese imports to 20%, while imposing a 25% import tax on both Canada and Mexico next Tuesday. These three countries represent the United States' top trading partners, and such tariffs could have far-reaching implications.
Moreover, Trump has suggested widespread layoffs of federal workers, which could lead to hundreds of thousands of job losses and potentially increase the unemployment rate. Lydia Boussour, a senior economist at the accounting and consulting firm EY, noted, “Increased uncertainty surrounding trade, fiscal, and regulatory policy is casting a shadow over the outlook.”
Economists have observed that Americans likely reduced their spending after a robust winter holiday season that resulted in a surge of credit card debt in December. In January, prices rose by 0.3% month-over-month, matching the increase seen in December. Core prices also rose by 0.3%, an uptick from the previous month’s 0.2% increase. If these trends continue, January's inflation rates could remain above the Fed's target threshold.
Currently, a major concern is whether the proposed tariffs will exacerbate inflation, slow down economic growth, or potentially create a combination of both adverse effects. A report from the Federal Reserve’s Boston branch indicated that 25% tariffs on Canada and Mexico, in addition to Trump's initial 10% import taxes on China, could elevate core inflation by as much as 0.8 percentage points. The last time Trump implemented tariffs in 2018-19, inflation remained largely stable, but those tariffs applied to a much narrower range of goods. Despite this, the economy still experienced a slowdown, prompting the Fed to reduce interest rates.
