KEY DATA: Consumption: +0.4%; Income: +0.3%; Prices: +0.1%; Ex-Food and Energy: +0.2%/ Claims: +3,000
IN A NUTSHELL: “Continued spending should keep growth at a solid pace.”
WHAT IT MEANS: Third quarter growth looks like it will be solid, but how strong is a different question. We got a hint as consumer spending held up solidly in July. Most of that came from growing demand for services. It is unclear from the report precisely what was bought, but given that July’s temperatures were well above average (according to NOAA) much of the spending may have been on utilities. Softening of vehicle sales led to a decline in big-ticket item purchases. On the income side, wage and salary gains remain solid but the rise over the year continues to decelerate. Inflation-adjusted wage increase was the smallest in eighteen months. In other words, purchasing power of workers is improving, but at a declining pace, which raises questions about the sustainability of strong spending. The savings rate declined a little more than expected. Households may be maintaining their spending levels by pulling from savings. As for inflation, it increased moderately, excluding food and energy, and was at the Fed’s 2% target.
Jobless claims rose modestly last week and remain around historic lows when adjusted for labor force size. So, I will repeat what has been said for this entire year and most of last year: The labor market is incredibly tight, despite what the limited wage increases imply.
MARKETS AND FED POLICY IMPLICATIONS: July was hot and if this past week is any indicator, August may have been hotter. Households are probably burning through their utility budgets to keep cool. While that is likely to mean the August spending number will be good, it is the rest of the consumption gains that will determine the real meaning of the data. Right now, it looks like third quarter consumer spending will be solid but significantly slower than the robust rise posted in the second quarter. It is likely the trade deficit will widen given the wild swings in things such as soy exports. It will take a huge increase in business investment to get growth anywhere near the 4.2% second quarter number. Going forward, the impact of the tax cuts on household spending growth will wear off. I doubt that investors will look that far into the future. Earnings are strong and pricing power is growing. If that power is used, inflation will accelerate. But until we actually see that happen, few will likely worry. The few who will be concerned make up the Federal Reserve. The next FOMC meeting is September 25-26. I still expect a rate hike at that meeting and another one in December.