KEY DATA: CPI: +0.4%; Over-Year: 2.2%; Less Food and Energy: +0.1% Over-Year: +1.7%/ Real Hourly Earnings: -0.2%; Over-Year: +0.2%
IN A NUTSHELL: “The continuing erosion of consumer spending power raises serious questions about future economic growth.”
WHAT IT MEANS: For the economy to continue to accelerate, consumers must step up to the plate and that is in question. Household spending power can only increase if the gains in income are not offset by the rise in prices. That means we have to look at both wages and inflation. On the inflation front, a jump in energy costs helped power another sharp rise in consumer prices in November. The surge in sales led to a jump in both new and used vehicle prices, while the cost of medical commodities also rose sharply. Food costs, thankfully, are going nowhere, though there continues to be pricing pressure for cakes and cupcakes. I am actually thinking of switching to fresh fruits and vegetables, whose costs are falling. (Not really.) In addition, apparel prices are plummeting, which is helping offset the rise in energy costs as you can put on warm clothes instead of raising the thermostat. Housing prices continue to rise at a moderate pace.
The greater than expected increase in consumer prices took a toll on household spending power. Hourly wages rose half as fast as inflation resulting in a decline in real, or inflation-adjusted income. Over the year, real wages rose minimally. Even if you adjust for the increase in hours worked, weekly earnings increased by less than one percent. In other words, people don’t have a lot more spending power today than they did a year ago. The solid gains in consumption were funded, at least in part, by a decline in the savings rate. That can continue only so long.
MARKETS AND FED POLICY IMPLICATIONS: The FOMC will release its statement soon and it will likely say that there was an increase in the funds rate. Given the direction and level of inflation, there is every reason for the Fed to hike rates. But the real threat to the economy is the continued, almost inexplicable lack of wage increases. As long as that continues, questions have to be raised about the capacity of the economy to grow. Yes, lower tax rates will incent some additional spending by businesses, but it is likely to be on labor-saving capital projects. Firms, if they can help it, are just not willing to pay their workers more. There are lots of anecdotal stories of firms bidding for key workers but the trend is not yet widespread enough to move the data. If we don’t get better wage gains, firms will have to be cautious in spending on capacity-increasing projects, regardless of their improved bottom lines. And companies who sell to the U.S. consumer have to question whether it makes sense to expand capacity in light of the lack of spending power growth. The tax cuts will help to some extent, but with most of the household tax cuts going to upper income households, the impact on overall spending may be disappointing. That, of course, will not derail investors as they know that the bigger companies who are listed on exchanges will, for the most part, make out like bandits.