KEY DATA: Consumption: 0%; Disposable Income: -2.3%; Prices: +0.4%; Over-Year: +3.9%; Ex-Food and Income: +0.5%; Over-Year: +3.4%/ Sentiment: +2.6 points
IN A NUTSHELL: “The economy remains on track, despite some of the craziness in the data.”
WHAT IT MEANS: Once again, we run into the problem of separating the headline number from the trends and the details. Today’s data may look ugly but that is just not the case, at least when it came to income and consumption. Yes, flat May consumer spending was nothing to write home about. But there was a large decline in durable goods demand that can simply be explained by the drop in vehicle sales from an unsustainably high April pace. The May annualized rate of vehicle sales was actually pretty good. Also, services spending rose sharply, indicating consumers are back out doing the things they had given up during the pandemic. As for income, the decline was the result of the changes in flows of government assistance. Wage and salary gains were fairly normal – decent but not great. As for the inflation numbers, they were troublesome. The headline and core price measures, which excludes food and energy, were up sharply and the change from 2020 accelerated once again. But even here, there are some special factors. The shortage of vehicles, in the face of strong demand, has led to a surge in vehicle costs. That should settle down once the chip supply problem is eased. And I doubt we are going to see the surge in energy costs, which were up over twenty-seven percent since May 2020, repeated. Inflation should settle down, but as I have noted before, what really matters is where it settles down to.
Consumer confidence will play a major role in determining the strength of future spending decisions and it picked up a touch in June. However, the rise in the University of Michigan’s Sentiment Index was nothing special. Most disconcerting was that the entire increase came from sharply rising expectations, as the current conditions measure declined. With so many states ending restrictions, it is hard to understand why people think growth is moderating, but that seems to be the case.IMPLICATIONS: Given that the federal government has been controlling income and state governments handling the reopening of the economy, it should not be surprising if there are some major ups and downs in the economic numbers. Consequently, we really don’t know the extent to which the private sector will be picking up the slack that ultimately will occur when the stimulus funds run out. That uncertainty is something the markets and especially the Fed will have to live with. The markets see no evil and are reacting accordingly. The Fed, though, is somewhat unsure. There are no clear signs that the monetary authorities want to end the bond-buying stimulus and that is good for the markets. But the massive additions to liquidity seem totally unnecessary, unless the members don’t know what the economy will look like once the private sector must stand on its own. So being cautious makes sense. It also makes sense if the Fed truly believes that once the current global supply chain issues are resolved, inflation will eventually return to its desired trend rate. There appears to be a total discounting of the idea that the current pricing power could be sustained. Will firms get use to the ability to keep earnings up by raising prices? Over the past couple of decades, the fear of raising prices has controlled inflation. The idea that that the same fear will reappear after companies have seen the benefits of price increases may be a wishful thinking.