What we learned about the economy this week

Despite eight consecutive interest rate hikes by the Federal Reserve over the last year and a chorus of economists predicting a recession in 2023, the U.S. economy is refusing to bow down.

After holding steady last month, data from the Commerce Department released Friday showed inflation bouncing back up, along with a strong increase in personal incomes.

The rebound in spending, incomes and inflation is thanks in large part to a resilient job market—the main obstacle in the Fed's quest to slow the economy.

New data from the Labor Department this week showed layoffs and jobless claims remaining below pre-pandemic levels despite a rash of payroll-shedding announcements from major corporations.

Americans have helped power the economy past the dismal expectations of many analysts and policymakers, helping the U.S. defy fears of a recession. But that strength could also prompt the Fed to push even harder against the economy with higher interest rates, risking a much steeper slowdown later in the year.

"After showing signs of cooling in late 2022, incomes and consumer spending came roaring back in January," wrote Diane Swonk, chief economist at KPMG, in a Friday analysis.

"The resilience of the consumer and accompanying acceleration in inflation are red flags to the Fed."

Good news for households and bad news for the Fed

Americans saw a large jump in take-home pay in January, with personal income rising 0.6 percent after falling since October.

This was paired with a jump in consumer spending of 1.1 percent, the largest monthly increase since President Biden signed off the final round of COVID-19 stimulus checks in March 2021.

“Real consumer spending staged an impressive rebound in January,” wrote Lydia Boussour, an economist with EY-Parthenon, in a statement.

“The report revealed that households splurged on a broad range of consumer goods and services last month, including motor vehicles, clothes, and hotel stays,” she said.

While the spending and income numbers are perhaps good news for American workers and households, the increase in inflation is bad news for the Fed, whose job it is to keep prices at a low level.

The Fed wants to see inflation at 2 percent annually, and it’s more than double that now.

The personal consumption expenditures (PCE) price index, the Fed's preferred gauge of inflation, rose 0.6 percent in January, beating analysts’ expectations of a roughly 0.4 percent increase. The annual inflation rate also rose to 5.4 percent, the first increase in annual PCE inflation since it peaked in June.

Moreover, “core” inflation levels, which remove the categories of food and energy that typically see greater price swings, are also elevated – more bad news from the Fed’s perspective.

Core PCE price rose 0.6 percent on the month, while the annual rate made its first upward movement in months to 4.7 percent.

The Fed may to see the latest price data as a reason to keep raising interest rates beyond its current target terminal rate of 5.1 percent, as reported in the bank's latest summary of economic projections.

"They have little choice but to raise rates by half a percent at the meeting in March. Brace yourself for a call for rate hikes by some members to hit 6% or higher at that meeting," Swonk wrote.

Recession is not imminent

With inflation coming back up, spending and income levels high, and a red-hot job market, discussion of a recession in the U.S. economy appears to be evaporating for the time being.

That’s despite a torrent of warnings about an inevitable recession taking hold of the economy from private sector economists and even some university economists last year. 

Speaking on the sidelines of the Group of 20 finance ministers meeting in India on Friday, Treasury Secretary Janet Yellen told reporters that the U.S. economy is “fundamentally in good shape.”

"Employment, you know, continues to increase. Households are in good shape. You know, we don't have balance sheet problems of the type that we had prior to the (2008-2009) global financial crisis," Yellen said, according to Reuters.

Consumers appear to be feeling some relief despite inflation remaining high, according to their spending habits and recent surveys.

The University of Michigan's consumer sentiment index, a closely watched gauge of how Americans feel about the economy, rose 3 percent in February from January, according to data released Friday. The index's current level of 67 is the highest since June 2022 — the peak of the COVID-19 inflation surge — but still down 20 points below the historical average.

Inflation is still stinging many Americans

Even so, consumers with major stock portfolios were the primary driver of that sentiment boost, according to survey director Joanne Hsu. Respondents to the Michigan survey also saw inflation rising higher in February than they assumed in January.

Yellen on Friday expressed particular concern with the increase in core inflation, which strips out food and energy prices. Economists consider core inflation to be a key indicator of how much leeway businesses have to keep raising prices and wages.

But many Americans are more focused on the rising costs of food, which are difficult for the Fed to control due to the supply chain constraints behind food inflation.

“I’m blown away by groceries,” Annie Paulsen, a retiree living in New York City told The Hill in an interview. “For the first time in many, many, many years in my life, I look at my grocery bill and I wonder about it.”