KEY DATA: Consumption: +0.1%; Disposable Income: +0.1%; Prices: +0.2%/ Confidence: -1.7 points
IN A NUTSHELL: “Sluggish consumer spending points to a weak third quarter growth number.”
WHAT IT MEANS: This week we received the final (for now) revision to third quarter GDP growth and the slight rise came from improved household consumption. It looks like the economy slowed sharply this quarter, in no small part because of a softening in consumer demand. Consumption ticked up in August, but when it was adjusted for inflation, it was actually down. Weakness in durable goods sales, basically motor vehicles, offset some increases in nondurables and services demand. The hurricanes were no helpful. But the uncertainty about consumers is not limited to the wrath of Mother Nature. Disposable personal income, while rising modestly, was also off when inflation was taken into account. It is hard to spend more when your purchasing power declines. Wage and salary growth pretty much disappeared and that does not bode well for future retail sales. Another warning sign is the savings rate, which edged downward again. Savings have declined five out of the last six months. On the inflation front, prices rose moderately overall but minimally when food and energy were excluded. The year-over-year increases in both the headline and core numbers are below 1.5%. Given the Fed’s target is 2%, there is a lot of room for prices to rise before the Fed has to worry about inflation.
Despite the chaos in Washington, the failure to reform the ACA and horrible hurricanes, consumer confidence remained pretty high in September. The University of Michigan’s Consumer Sentiment index did decline, but the level is strong. For most people, the hurricanes hit somewhere else and while there was concern for those who were hit by the storms, the impacts were not felt directly by most Americans. Thus, confidence did not tank.
MARKETS AND FED POLICY IMPLICATIONS: It looks like the economy fell back to its normal growth rate, or even lower, in the third quarter. We don’t have the September numbers, but given the hurricanes, it is likely that consumer spending will come in at half the 3.3% pace posted in the spring. But eyes are now turning to tax reform/tax cuts and the administration’s proposal has already come under intense fire since there are lots of winners and losers. That is always the case with any changes in policy. But the major issue is the impact on the deficit. Working backwards, the supporters have come up with a growth rate that implies the plan will pay for itself. If you believe that, I have both a Broadway show that I am producing and a bridge I am selling and you can have as much of each as you like. But it is not just bogus growth estimates that create risks to the plan. It provides significant tax breaks for upper income households, something the administration pledged not to do. By eliminating the state and local tax break, it creates the likelihood that upper-middle-income households will see their taxes rise not fall. And if the past is any example of how the money will be spent, don’t expect the repatriation of foreign earnings to lead to a lot of new capital spending. You can argue for or against all of the changes in the plan but they will create major disagreements. The one good thing is that the battle for tax reform/tax cuts has begun, though I suspect we will wind up with some cuts and not a lot of reform.