September Consumption and Income

KEY DATA: Consumption: +0.4%; Disposable Income: +0.2%; Prices: +0.1%; Ex-Food and Energy: +0.2%

IN A NUTSHELL: “The slow income growth may not be stopping consumers right now, but it is likely to start doing so very soon.”

WHAT IT MEANS: The issue facing us right now is whether the economy can sustain the strong growth we have seen for the past two quarters. The income data don’t seem to support that likelihood. Consumption expanded briskly in September, led by a surge in durable goods spending. But demand was solid across all categories and it has been strong for most of this year. So, what’s the problem? It’s all about sustainability and that comes from income. Personal income growth has tailed off with wage and salary gains moderating. Farm income fell sharply, likely the result of the trade battles. But the yin and yang of farm income is not my greatest worry. What is truly worrisome is the savings rate, which has declined consistently since February. The September rate was 6.2%. Using recent income distribution data, if the top 20% saved just 12% of their income, a very conservative estimate, the bottom 80% would have no savings. If the second highest income group had savings rate at the average, also conservative, the middle and bottom two income groups would have a negative savings rate of nearly 6%. In other words, to maintain the consumption levels we have been seeing, most households have to be dissaving and that is simply not sustainable. And while inflation remains fairly tame, any acceleration in price increases will simply put further pressure on consumption.

MARKETS AND FED POLICY IMPLICATIONS: While the tax cut-induced spending sugar high continues, the end is likely near. And the problem remains spending power. While some businesses have been announcing sharp increases in wages, especially the minimum wage, that attitude has not been adopted universally. Thus, we have yet to see any acceleration in wage and salary gains. Instead, the added spending seems to be coming from savings and there is simply no way that can continue much longer. It is also hard to imagine that inflation will not continue to accelerate, further reducing spending capacity. The year-over-year gains in real/inflation-adjusted earnings will start decelerating early next year, not only because of inflation but also because the impact of the tax cuts will already be in the income numbers. While investors and some stock market pundits and politicians rail at the Fed for raising rates, it’s the issue of worker compensation that is really the greatest concern. I know this sounds familiar, I write it several times a month, unless wages and salaries, not just benefits, start increasing faster, we are headed back by to a 2% to 2.5% economy. The Fed would actually love that growth pace as it is sustainable. That way, they can raise rates to the neutral level without having to start stepping on the brakes. Stronger growth, though, could force them to hike rates even more. Indeed, the members have already warned that is possible. So watch what you wish for as no good economy goes unpunished.