KEY DATA: Real Consumption: +1.5%; Real Disposable Income: -0.5%; Inflation: +0.6%; Ex-Food and Energy: +0.5%/ Orders: +1.6%; Private Capital Spending: +0.9%/ Pending Sales: -5.7%/ Sentiment: -4.4 points
IN A NUTSHELL: “Consumers may still be spending money, but with incomes being eaten away by inflation and confidence falling, a slowdown should be expected.”
WHAT IT MEANS: This economy has a lot of staying power. At least through January, households continued to empty their wallets, spending like crazy. Consumption surged, rising much more than expected. Demand for durables skyrocketed, after having declined sharply in December. There was a large rise in nondurables demand and a more restrained, but still solid increase in purchases of services. Even adjusting for inflation, real total consumer spending was up significantly, but it is not clear those high spending levels can be sustained. Disposable income rose minimally in January but adjusting for inflation it dropped like a rock. The government’s ending of some stimulus programs continues to reduce income sharply. The savings rate declined to its lowest level since December 2013. And there is little reason to think the large price increases we saw again in January will fade quickly. Energy costs were already high, and the Russian invasion may exacerbate the problem. The global supply chain is untangling, but it is still a mess, just less so. The supply of homes is largely nonexistent, so housing prices should continue to rise. And corporate pricing power remains in place. At the same time, consumer confidence continues to fall. In other words, all indicators point to slower consumption in the months ahead.
Businesses are also spending like mad. Durable goods orders jumped in January, even when removing volatile aircraft orders. The measure of investment activity, private nondefense capital expenditures, rose sharply. Companies are betting on the future. Given their ability to raise prices and maintain earnings, that makes sense. But again, if household spending power continues to fade, so should demand, which raises questions about future investment.
Consumers, facing all the issues that are out there, are getting pretty upset. The University of Michigan’s Consumer Sentiment Index declined again in February, with both the current conditions and expectations indices nosediving. The level is the lowest in over ten years. The measure did pick up in the second half of February, but with the Russian invasion and further increases in gasoline prices in the offing, I would not be surprised to see another drop in confidence in March.
Can home sales remain strong in the face of rising prices and interest rates? That is not clear. The National Association of Realtors’ Pending Home Sale Index, a measure of future sales, fell in January for the third consecutive month. Only the West posted a rise, but that was nothing special. With rates and prices up, you would expect demand to fade. But currently, the historically low level of inventory makes it unclear whether the issue is demand or supply.
IMPLICATIONS: That was then, and this is now. The economy did quite well in January, but the indicators are concerning. Household spending power, measured by inflation-adjusted disposable income, is going in the wrong direction. Workers may be getting big pay increases, but the goods they are buying are costing even more. That cannot be good news for future demand, especially since the factors driving up prices are mostly still in place. Though the invasion of Ukraine may not resonate with everyone, any impacts it has on energy costs will. The markets seem to think that the sanctions on Russia, which were designed to limit the impact on energy costs, will likely do just that. Oil and gas prices declined today. But we are just in stage one of the battle and while the military outcome was never really in doubt, what comes next is. The direction of energy costs remains uncertain, with the risk still to the upside. If the sanctions have the potential that the President claims, then as he mentioned, we need to wait a month to see how deeply they hurt Russia and its trading partners. There is nothing good that can come from the invasion in the short-term. In the mid-term, if it causes Europe to wean itself from its dependence on Russian energy, then something positive may happen, though at a massive cost to the Ukrainian nation.