KEY DATA: Consumption: +0.3%; Real: +0.1%; Income: +0.2%; Real: -0.1%/ ECI (Over-Year): +2.7%; Wages: 2.9%; Benefits: +2.2%/ Confidence: +0.5 point
IN A NUTSHELL: “Rising consumer confidence can take the economy only so far given the relatively modest gains in income.”
WHAT IT MEANS: Yesterday’s GDP report gave us a full view of where household spending stood at the end of last year, so the December numbers only provide some additional detail. That said, it looks like household spending is decent but there are questions about the sustainability of the pace reached last year. On the surface, it looks like household did spend money moderately in December. But when inflation is factored in, real consumption gains were unexceptional. Vehicle sales, which peaked in 2016, continued to slowly tail off, while demand for nondurable products and services, when inflation-adjusted rose somewhat modestly. The reason is simple: Income is just not growing fast enough to support even the modest to moderate spending increases. Real disposable income, which adjusts for both inflation and taxes, declined in December, the second month in the past three that happened. As a consequence, households had to save less and the savings rate declined. The level is still fairly high, so households should be able to draw from their savings more to sustain the spending pace. However, it could become more difficult for consumption to accelerate if the income gains remain tepid.
And there are few indications that businesses are willing to pay more to their workers. The fourth quarter Employment Cost Index, which includes both wages and benefits, rose at a moderate pace. Wage gains were solid, but benefits were up modestly over the year. The year-over-year increase in wages and salaries peaked in 2014 and since the third quarter of 2017, it has steadily decelerated. Firms may have switched to providing non-pecuniary benefits, which many employees prefer, but that does nothing to spending power. The opposite is true for government, which has minimal power to provide certain types of perks. Benefit costs are rising faster in that part of the economy but wage gains are slower.
With jobs plentiful and the unemployment rate at historic lows, it should not be a surprise that consumer confidence remains high. The University of Michigan’s Consumer Sentiment Index rose modestly in January, but the level is only slightly below the peak in this cycle that was reached in March 2018. The current conditions measure edged down while expectations improved. Both are at quite high levels as well. MARKETS AND FED POLICY IMPLICATIONS:The administration continues to insist that the economy will grow at a 3% pace or even more. We could get a quarter here and a quarter there of stronger growth, but over an extended period, there are no factors out there that suggest that will will happen.And there is nothing wrong with 2% growth. Yes, it is back to the future in that the “dreaded Obama growth rate” (similar to the Dread Pirate Roberts) has returned. But as I and many other economists have argued, that is trend growth.Given the tight labor markets, growth well in excess of trend could put a major strain on labor markets and the ability to restrain wages could dissipate rapidly. Which means we don’t even want 3% growth, unless rising inflation and interest rates is your preferred goal. It appears that trend growth can be sustained for a while longer without creating major bubbles, so let’s embrace it not attack it.