Concern about the future has constrained the U.S.stock market’s reaction to very good news about current consumer spending.
As of 1:30 today, Tuesday May 31, the Standard and Poor’s 500 index was off 0.15% or 3.14 points to 2095.92. The index had opened at 2100.13, just above the 2100 level that has marked the top of the recent trading range, after closing on Friday at 2099.06.
A report from the Commerce Department this morning showed consumer spending picking up by 1% in April. Wages and salaries gained 0.5%. All that argues that the U.S. economy is set to rebound after weak growth in GDP in the fourth and first quarters. Economists had expected consumer spending to climb 0.7% in April.
But the Conference Board index for May that measures consumer expectations for the next six months fell to 79, the lowest level since November 2015 from 79.7.
There’s a good likelihood that the difference between actual consumer spending and consumer worries about the next six months will get resolved in favor of actual dollars over emotions. But nonetheless, the drop in future expectations is enough to take some of the shine off consumer spending.
Add in the recognition that higher consumer spending means stronger economic growth means greater likelihood of an interest rate increase from the Fed in June or more probably July and you can understand the market’s stutter step as it thinks about breaking above 2100.
U.S. financial markets have apparently decided that the disappointing first quarter GDP data released this morning are just another example of first quarter weakness. It’s the third straight first quarter GDP read that has shown a U.S. economy headed toward stagnation–and in each case the economy recovered to show better growth in the rest of the year. In 2015, for example, first quarter GDP grew at a 0.6% rate in the first quarter before recovering to post a 3.9% annualized rate of growth in the second quarter. In 2014 the first quarter saw a 0.9% drop in GDP ahead of a 4.6% gain in the second quarter.
With that as backdrop, the Dow Jones Industrial Average was off just 0.11% as of noon New York time; the Standard & Poor’s 500 stock index and the Nasdaq Composite index both picked up a bit of ground, climbing 0.16% and 0.50%, respectively.
Economists surveyed by Bloomberg had expected growth of 0.1% to 1.5% with a median forecast of 0.7%. In the fourth quarter of 2015 the U.S. economy grew at an annualized rate of 1.4%.
The weakness came across the board. Consumer spending, 70% of the U.S. economy, climbed by just 1.9%, down from 2.4% growth in the fourth quarter. That was the slowest growth in consumer spending since early 2015. Driven by a continued collapse in energy industry capital spending and weak demand from overseas, business investment showed the largest slump in almost seven years, dropping at a 5.9% annualized rate.
One reason that economists–and the markets–are willing to overlook this quarter is that conditions remain favorable for growth in the remainder of 2016. Gasoline prices remain low, new claims for unemployment dropped last week to near a four-decade low, disposable income adjusted for inflation rose 2.9% in the first quarter, up from 2.3% in the fourth quarter of 2015. Consumers put a big chunk of that gain in income into savings with the saving rate moving up to 5.2% from 5% in the fourth quarter.
Stripping out the effect of shifts in inventory and trade, a measure called final sales to domestic purchasers, climbed by a 1.2% rate. That was better than the GDP growth rate (because companies continue to cut inventories) but still below the growth in final sales last year. In fact this was the weakest final sales number since the third quarter of 2012.
Does it make the disappointing retail sales number this morning any better because we can explain why retail sales fell by 0.4% in March?
I don’t think so. And, in fact, the specific explanation is worrying—if only slightly at this point–for growth in the U.S. economy in the coming months.
Economists surveyed by Bloomberg had expected that March retail sales would be flat so the 0.4% decline is a surprise. Especially, coming as it does, after 1% growth in February.
The likely explanation, and it’s convincing to me, is that what we’re seeing in the March numbers is a delayed reaction to the tax increases included in January’s deal to avoid the fiscal cliff. It’s taken a while for consumers to adjust their spending downward to account for the 2-percentage point increase in the Social Security withholding tax that was part of that package. The Tax Policy Center, estimates that 77% of U.S. households are paying higher taxes in 2013 because the fiscal cliff deal let cuts to the Social Security tax rate expire. In 2012 that reduction in Social Security withholding was worth about $1,000 to a family at the $50,000 income level.
If the lower retail sales numbers are a delayed result of that tax increase, instead of a reaction to a temporary news event or sentiment shift, then we could be looking at a drag on U.S. growth that could persist for much of 2013. Read more
This morning’s U.S. inflation numbers are good news if you live in the alternative reality called the financial markets. However, if you live in the real world—you know the one where you buy things and have to make income and outgo match each month—the inflation news was remarkably bad.
The headline consumer price index climbed 0.7% in February. That’s the biggest jump in almost four years. It’s also a significant increase from January and December when headline inflation was flat. Economists had expected an increase of 0.5% for the month.
Core inflation, the number the Federal Reserve and financial markets watch, presented a much better picture. The core inflation rate, which excludes volatile food and energy costs, rose just 0.2% in February. That was actually a drop from the 0.3% increase in core inflation in January. The February core inflation number exactly matched expectations among economists surveyed by Briefing.com.
Why the big difference in the headline and core inflation rates? Two guesses—food or energy—and the first guess doesn’t count.
It sure wasn’t the result of soaring food prices. Food prices rose just 0.1% in February.
So it must have been energy, right? Yep, energy prices climbed 5.4% in February (after falling for three consecutive months) on a huge 9.1% increase in gasoline prices.
In financial world all this is reasonably good news. The core inflation measures the Fed watches showed no signs that core inflation might be on the upswing or that inflation expectations might be rising. Nothing in these numbers to suggest that the Federal Reserve, scheduled to meet next week, should consider ending its monthly $85 billion program of quantitative easing early. That’s especially true because the most likely explanation for the increase in gasoline prices—soaring prices for the credits that U.S. refineries buy so they don’t have to blend quite so much corn-based ethanol into their gasoline—can be passed off as a short-term technical problem.
On the other hand, in the real world, these inflation numbers are bad news. Read more
This sure isn’t sustainable.
In January, according to data the Commerce Department released this morning, personal income fell by 3.6%. That’s worse than the 2.4% drop expected by economists surveyed by Briefing.com, and worse that the 2.6% drop in December. It was the biggest drop since January 1993.
Personal spending, however, rose in January by 0.2%. That was equal to the 0.2% increase in December and matched economists’ expectations.
You don’t have to look far to find a reason for the drop in income: the expiration of the payroll tax cut as a result of the fiscal cliff deal took a bite out of paychecks. (Also in December companies rushed to pay dividends and bonuses before projected changes in tax rates in 2013. Income from these categories dropped in January as a result of the early payouts.)
And you don’t have to scramble to find out where the money for increased spending—even as incomes fell—came from. The savings rate—the percentage of disposable income households don’t spend—fell to 2.4%. That’s the lowest rate since November 2007.
None of this bodes well for February or March when higher tax rates will still be in effect, family savings will be spent down (at least a little), and the effects of government spending cuts from the sequester that started today will have started to spread through the U.S. economy.