Consumers dip into savings to boost spending

Aided by an improving economic outlook, consumers dug into savings last month and boosted outlays, helping the economy end the year on a positive note.

Consumer spending jumped a better-than-expected 0.7% in December. But a respectable 0.4% rise in personal income was not enough to fuel the impressive jump in outlays, as consumers tapped into savings, knocking down the personal savings rate from 5.5% in November to 5.3% in December.



The economic recovery has been uneven and fragile since the recession officially ended back in the summer of 2009.  Manufacturing and the rebuilding of depleted inventories, along with growth in China and emerging markets, has supported the U.S. economy.

But housing has faltered and consumers, who drive 70% of economic activity, have been reluctant to part with their dollars amid job insecurities.

Sovereign debt worries in Europe brought about instability in the financial markets last summer, cooling what was already a weak recovery and raising fears that the U.S. economy might be headed for a double-dip recession.

Growth, however, resumed in the fall as financial markets calmed and a new round of quantitative easing by the Fed lifted commodity and stock prices.

Now it appears that consumers are finally doing some of the heavy lifting necessary to put the economy on a self-sustaining path.



Price stability
Retail inflation, which looms as a possibility longer-term, is showing no signs of bubbling up at the present time.

The core Personal Consumption Expenditures Index, which is a broad look at the price level and is closely followed by the Fed, continued its downward drift, dropping from 0.8% year-over-year (y/y) in November to just 0.7% y/y in December.

With unemployment above 9% and retail inflation stuck at an uncomfortably low level for the Fed, don't expect the Fed to hint at an exit strategy any time soon.

The consumer takes the reins of the recovery

Consumer spending lights up GDP

At first glance, the 3.2% annualized increase in GDP appears to be a disappointment since economists surveyed by a number of organizations had forecast 3.5%.

However, a steep decline in inventories, which detracted 3.7 percentage points from growth, masked what was otherwise a rather impressive report.


(supplied by the BEA)

Consumer spending accounted for 3 percentage points of the increase and rising exports added another full percentage point.  Real final sales, which excludes changes in inventory, grew a very robust 7.1%, the best gain since the second quarter of 1984!

Nonetheless, the Fed made it clear on Wednesday it remains unconvinced that the recent improvement in the economy will be enough to take a significant bite out of the jobless rate, and it sees no need to alter its plan to pump hundreds of billions of dollars into the economy.

Moreover, the advance data showed that core inflation rose at an annual rate of only 0.4% in the final quarter of the year, which is well below the Fed’s comfort zone of near 2%.

Labor costs, a key component in the inflation equation and something the Fed closely follows, haven’t changed much in recent quarters, so the argument from policymakers that rising prices won’t be an issue in the short term has some credence to it.


(supplied by the BLS)

Inflation could become a problem down the road, but that is not the Fed's immediate concern since it believes it can craft and implement an exit strategy before inflationary pressures build through the economy.

Looking ahead, any easing in already tight credit conditions could unleash more pent up demand, which would continue to boost output.  Plus, the contraction in inventories, which weighed on GDP, might actually fuel gains later in the year, as businesses re-stock shelves in order to meet both global and domestic demand.


(click to enlarge)

No doubt about it, headwinds remain, such as housing, sovereign debt worries in Europe and a reluctance among banks to lend, but the recovery is broadening and accelerating, which, if history is any guide (see chart and 30-year history above), should encourage companies to boost hiring.

Separately, a look at today’s advance GDP number is also available at Examiner.com.

New home sales leap at year-end

For an industry that has been battered for several years, new homes sales managed to jump by nearly 18% at the end of 2010, rising to a seasonally adjusted annual rate of 329,000. At the current pace of sales, the supply of homes on the market dipped from 8.0 months to 6.9 months. 

Still, sales are 17% below one year ago, and at 321,000 new homes sold in 2010, builders saw the smallest number of sales since records began back in 1963.



Sales appear to be stabilizing, and we are even seeing a small uptick in single family building permits (see Housing – the soft underbelly of the economy). Moreover, the actual supply of new homes continues to recede (see chart below) and stands at the lowest reading since the 1968.



But any unexpected rise in sales could very quickly be met by the shadow inventory that banks still hold, which would likely keep pressure on prices.

Keeping with recent themes, a recovery in the labor market, coupled with relatively stable interest rates and more reasonable credit conditions, would go a long way in instilling confidence and putting a firmer foundation under what has been an unstable market.

Fed mentions rising commodity prices but otherwise, only tweaks language

It was no surprise that the Fed concluded its two-day meeting without any changes in interest rates and maintained its previously-stated goal of buying $600 billion in longer-term Treasury securities. A first look and more formal review of are available at Examiner.

In this post, I’d like to compare changes, or in this case the minor tweaks to the language, with the current statement and the December statement.

So let's jump in.

Following the December 14, 2010 meeting, the Fed said: "Information received since the Federal Open Market Committee met in November confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring down unemployment."

Not much change in today’s meeting as the Fed began the press release: "Information received since the Federal Open Market Committee met in December confirms that the economic recovery is continuing, though at a rate that has been insufficient to bring about a significant improvement in labor market conditions."

The adjustment is likely related to the 0.4 percentage point drop in December’s unemployment rate.

Continuing, the FOMC noted that “Growth in household spending picked up late last year...” versus December’s "Household spending is increasing at a moderate pace…” The upgraded assessment reflects the rise in spending at the nation’s retailers.

In the meantime, and in another sign that the recovery is slowly accelerating, the Committee maintained its view that “business spending on equipment and software is rising,” but it removed the language stating that the pace is “less rapid that earlier in the year.”

Lastly, the Fed is finally taking note of the rise in commodity prices, which was absent last month.  But just mentioning what is going on it commodities is simply acknowledging the obvious. And failing to state the obvious might seriously bring into question the Fed's publicly-stated goal of price stability. 

Still, Committee members are not expecting any out break of inflation, as they continue to insist (and rightly so) that “longer-term inflation expectations have remained stable, and measures of underlying inflation have been trending downward.”

In conclusion, don't expect any changes in policy in the near term. Employment growth will have to significantly accelerate, and the rate of core inflation will have to creep higher before we hear any discussions among policymakers of an exit strategy.

If there is any question about the near-term direction, the Fed's opening sentence that the recovery continues "at a rate that has been insufficient to bring about a significant improvement in labor market conditions" should leave little doubt.

Housing – the soft underbelly of the economy

The gradual economic recovery that many of us are witnessing has been slow and uneven for much of the last 18 months, as evidenced by the stubbornly high rate of unemployment.  But recent data suggest that the recovery is accelerating and broadening.

The service sector is displaying a renewed vigor, retail sales are growing, and more importantly, weekly jobless claims are in a downward trend.  And the dip in layoffs appears to be boosting consumer confidence according to a report released by the Conference Board today (see my piece on Examiner entitled Consumer confidence jumps to eight month high).

Despite the improvement in a growing number of sectors of the economy, housing continues to muddle near the bottom amid the lack of any meaningful job creation, fears over the direction of prices, tight credit and the still high-level of foreclosures that continue to weigh on the market.

Brand spankin’ new – a look at new homes for sale
Housing starts, which directly impact GDP, fell 4.3% last month to a seasonally adjusted annual rate of 529,000 units.  Starts among single-family units fared even worse, dropping 9.0% to 417,000 units.  News, however, was a little bit better when building permits, which are more forward looking, were taken into account.



Though single-family permits have fallen from the near-term high early last year (see chart above) that was aided by the home buyers tax credits, it does appear the market is stabilizing and even edging higher.  Still, there is little reason for a burst of enthusiasm, as the market continues to glide along the bottom.

Thin inventory...sort of
One factor that favors an uptick is the near absence of homes available from builders.  As the second chart below reveals, the absolute number of houses for sale from builders is at the lowest level since the 1960s.  Any jump in demand would likely catch many off guard and could support a burst of new construction.

However, the large number of foreclosures of late model homes that compete for the new home buyer remains a very large overhang for the market.



And builder confidence and traffic – see third chart below – continue to wallow at very low levels (a reading of 50 suggests that home builders are neither confident nor pessimistic).  Remove the artificial boost in sentiment brought on by the home buyers tax credit and builders are still in a sullen mood.



Looking at the number of new homes sold (chart below), one can quickly see why the industry isn’t ready to celebrate a recovery anytime soon, as 2010 was just a plain awful year.

The expiration at the tax credit at the end of April served mostly to move summer sales into the spring, and the market has yet to return to levels seen during the worst of the national recession.



More than one owner – what’s up with existing homes
Sales of existing homes make up over 90% of the housing market.  And though they do not directly affect GDP, the ups and downs in the market support or detract from a number of related industries.

Existing home sales, as the chart below indicates, continue to suffer but have managed to come off extremely low levels that were seen after the tax credit’s expiration.  That's at least one silver lining in the still-struggling residential market.



In December, sales jumped a solid 12.3% to a seasonally adjusted annual rate of 5.28 million units.  The uptick in mortgage rates may have actually been partly responsible for the spike in sales, as the rise may have encouraged those who feared rates might go even higher.

That may be unlikely in the short term, but as any realtor will tell you, a sudden and unwanted movement in mortgage rates can encourage fence-sitters to take action.

Competing forces
Mortgage rates remain at historically low levels, and combined with falling home prices, affordability is at a record high.  And there’s plenty of inventory to choose from in most locales. That should encourage buyers.

But the tailwind from low mortgage rates and reasonable prices is being offset by continued worries about the job market, still-tight lending standards and fears that a flood of new foreclosures could put renewed pressure on prices.

So what's needed? Meaningful job creation, further gains in consumer confidence, no ugly surprises in mortgage rates, easier access to credit and a downward drift in foreclosures (unfortunately, this year and not last year is expected to be the peak).

That's a tall order for an economy that continues to suffer from the lingering impact of a very nasty recession.

Weekly jobless claims tumble

The holidays at the end of the year normally render the weekly jobless claims data a bit suspect, even with the seasonal adjustments that always accompany the release.

But we are now starting to make some headway into the new year, and the latest release is starting to provide some clarity on the labor market.  Fortunately, there’s good news to report.

Weekly initial jobless claims tumbled 37,000 to 404,000, while the 4-week moving average slipped a solid 4,000 to 411,750.



Though still elevated, the dip to near 400,000 is a sign the labor market is slowly on the mend. It also suggests that business activity is picking up, reducing the unfortunate necessity for layoffs.

I’ll be looking for claims to consistently fall below 400,000, which would be a strong indication that the acceleration in economic activity that began in Q3 is continuing into 2011.

Outside of energy, certain commodities, retail inflation is not a problem

Late last week, the government reported that the closely-followed Consumer Price Index increased 0.5% in December, as a steep 4.6% rise in energy costs led the way.  Talk of higher food prices, however, have yet to materialize, as costs rose just 0.1%.

The core rate of inflation, which removes the more volatile energy and food categories, remains extremely low, rising 0.1% for the second month in a row.  For the calendar year 2009, prices increased 1.5%, while the core rate remains uncomfortably low – at least for the Fed – at 0.8% (see chart below).



Interestingly, with all the talk about higher food prices around the world, food at the retail level is up just 1.5% from one year ago and up just 1.7% on an annualized basis over the last three months.  That means we aren’t seeing much in the way of price increases at the grocery store. 

However, wholesale food prices have jumped at annualized double-digit rates in three of the past four months so increases may be on the way among grocery stores.

Nonetheless, overall inflation should remain at low levels for quite some time despite the latest round of QE by the Fed and deficit spending by the government since forces that are holding price increases at a minimum far outweigh unsettling trends that could unleash a new wave of inflation.

First, the unemployment rate remains very high, which has been putting downward pressure on wages – wages make up the largest costs for most firms.

Those who have jobs are willing to settle for tiny wage increases, substituting job security for a more robust lifestyle, and the large pool of skilled labor that is available for most industries means that businesses don’t have to bid up wages and benefits just to attract the best and the brightest.

Second, capacity utilization has rebounded but remains at an historically low level. Since manufacturers can still boost production without worrying about bottlenecks or shortages, there isn’t the concern that further gains in demand might boost prices.

In addition, all but the smallest increases in prices are difficult to implement amid fears that customers might just run into the willing arms of competitors.

Third, and an important part of the anti-inflation equation, inflation expectations remain muted, which also makes if very difficult for companies to hike prices.

Inflation brewing over the longer-term?
No doubt about it, energy costs are up and a host of increases in commodity prices are, at the margin, putting some pressure on firms.  Still, productivity gains have helped to offset rising commodity prices for most, and even if companies wanted to boost prices, the generally sluggish economy makes it difficult to do so.

Nonetheless, the huge amount of liquidity available to support economic growth, and secondarily, the rise in commodities, does provide support for the inflation argument down the road.

In order to prevent today’s disinflationary environment from morphing into an inflationary environment, the Fed will have to time its exit strategy just right, not dampening growth by doing so too soon or waiting too long and unleashing the inflation genie from the bottle.

Looking at the Fed’s historical record, it seems unlikely that it will pull the plug too soon.  More likely, the Fed will want to see a sizable drop in the unemployment rate before it embarks on a new path.

Retail sales post sixth-straight rise

Consumer sentiment slips

Retail sales for December did not quite measure up to expectations, but the sixth-straight monthly increase indicates that the improving economy continues to support spending.

Sales grew a respectable 0.6% last month, which comes on top of a 0.8% gain in November.  Ex-autos, sales were up 0.5% in December following an impressive 1.0% the previous month.  Removing gasoline and autos, so-called core sales rose 0.4% after increasing 0.6% in November.

Overall, the gains over the final two months of the year indicate a fairly upbeat 2010 holiday shopping season, though the smaller rise in December may indicate that bargain-conscious consumers were drawn into the malls by early deals offered prior to Black Friday.

 

Still, the rise suggests a resilience among consumers, especially given that unemployment remains high, job creation has been relatively anemic, and housing prices have been flat or declining.

Now that the Bush tax cuts have been extended for another couple of years and Congress has gone along with the president’s proposal for a temporary two percentage-point reduction in the social security payroll tax, consumers will have extra cash to fuel additional gains this year.



In the meantime, early data from the University of Michigan’s consumer sentiment survey show that confidence unexpectedly dipped in January, dropping from 74.5 in December to 72.7.

One year inflation expectations rose, mostly due to higher gasoline prices, but inflation expectations remain well-anchored going out five years. 

That’s good news since the Fed shows no signs of delaying or easing up on their planned purchases of $600 billion in government securities.



Though disappointing, the dip is not that worrisome as the overall upward trend coming out of the summer slowdown remains intact.

Seasonal factors may be responsible for the jump in weekly jobless claims

The drop in weekly initial jobless claims, which fell to a 2 1/2-year low of 391,000 two weeks ago, has come to a screeching halt, according to the latest data.

The Department of Labor reported today that weekly claims increased 35,000 to 445,000, while the 4-week moving average gained 5,500 to 416,500.

The rise we’ve seen over the past two weeks would normally be troubling, but according to Bloomberg News, special factors contributed to the rise.

“The Labor Department believes the week's surge reflects administrative backlog built up during the shortened weeks of the holidays. They also note that many claimants postponed filing until the New Year, a move that will increase their benefits.”

Although the government attempts to account for seasonality around the holidays, unforeseen factors can sometimes muddy the data, and the Labor Department’s explanation seems reasonable.

Last year, however, similar explanations were given during the first weeks of 2010, and when claims remained at elevated levels in February, nasty winter weather was cited.  Eventually, it became clear that growth in the economy was not accelerating, and stubbornly high jobless claims were not due to an special factors.

This time around, similar trends are bear watching, and we should know soon enough whether quirks surrounding Christmas and New Years were the reason for the jump.

Still, given an improvement in most data, with the exception of housing which will remain a drag on growth, a downward drift in jobless claims is probably the most likely path during the current quarter.

Bernanke sees evidence of a self-sustaining recovery

But expect slow progress on the job front

Fed Chairman Ben Bernanke, in his written testimony before the Senate Budget Committe, said he sees "increased evidence that a self-sustaining recovery in consumer and business spending may be taking hold."

Bernanke pointed to a 2-1/2 percent rise in real consumer spending in Q3 and evidence that Q4 expanded at a faster pace.  He also said business investment in new equipment and software has grown robustly in recent quarters, as firms have started to replace aging equipment and make investments that had been delayed during the downturn.

However, he noted that housing remains depressed amid the "overhang of vacant houses."

Stubbornly high unemployment
Despite his belief that growth will likely be "moderately stronger in 2011 than it was in 2010," an improvement in the labor market could lag.

"After the loss of nearly 8-1/2 million jobs in 2008 and 2009, private payrolls expanded at an average of only about 100,000 per month in 2010 - a pace barely enough to accommodate the normal increase in the labor force and, therefore, insufficient to materially reduce the unemployment rate."

Furthermore, Bernanke forecasts that the unemployment rate may only dip to about "8% two years from now...and it could take four to five more years for the job market to fully normalize."

And the shortfall in job creation has to be the number one problem facing the economy today.  After a sluggish start to the recovery in the second half of 2009, the economy hit a soft patch last summer that was tied to the financial instability caused by the debt crisis in Europe.

We've managed to avoid a double-dip recession in the U.S., while spending is picking up, we're seeing a broadening of the recovery, the Leading Index is pointing to further gains, and jobless claims are in a downward trend.

Still, housing is hugging the bottom and the lack of a more robust recovery has yet to force the hand of hiring managers across the country.  Until GDP begins to consistently grow at a faster pace - somewhere between 4-5%, we're not going to see much progress on the labor front.

Fiscal insanity
In the meantime, Bernanke did not shy away from the need to talk about the nation's fiscal imbalances.

He said the current path is "unsustainable," and if government deficits grow as projected by the Congressional Budget Office, "the economic and financial effects would be severe."

So far, few in Congress have seriously talked about the president's panel that has provided a blueprint for credible deficit reduction. Waiting for a crisis to sneak up and create havoc cannot be the only option.

Weekly jobless claims jump in latest week

But downward trend intact

Weekly initial jobless claims jumped 18,000 in the latest week to 409,000, while the 4-week moving average, which eliminates much of the week-to-week volatility, slipped 3,500 to 410,750.

This week’s increase shouldn’t be taken as a sign that progress in the labor market is being stifled, in my view, as the numbers tend to gyrate every seven days.  More importantly, as the chart below reflects, along with the drop in the 4-week moving average, the gradual reduction in the number of initial claims is continuing.



An accurate picture of jobless claims can sometimes be difficult to capture at year-end because of the difficulty in accounting for seasonal discrepancies, i.e., we tend to get plenty of noise in the data.

The large drop last week, followed by a fairly decent increase this week, seems to bear this out, though the Labor Department said there weren’t any special factors to consider, according to Bloomberg News.

We will get a clearer picture in the coming weeks, as January’s numbers provide a post-holiday look at claims, but recent progress suggests the recovery is broadening and is helping to strengthen what so far has been a weak labor market.

ISM non-Manufacturing Index shows recovery is broadening and accelerating

We’ve had a string of solid reports out in the last week, including a drop in weekly jobless claims, gains in manufacturing and retail sales, and today, a report by ADP that the private sector created nearly 300,000 new jobs last month (see ADP report shows huge jump in employment).

But the good news on the employment front is also being shared by a very respectable increase in the ISM non-Manufacturing Index from 55.0 in November to 57.1 in December. A reading of 50 suggests the service sector is neither expanding nor contracting.



December’s gain is the fourth consecutive monthly increase, indicating that the economy is shrugging off the slowdown experienced during the summer.  Further, key subcomponents, new orders and production, posed sizable increases, foreshadowing additional gains during the first quarter of this year.

A couple of notable items, however, the employment index slipped from 52.7 to 50.5, while prices paid continues  to put modest pressure on profit margins.

Employment in focus
Attention is quickly shifting to Friday’s labor report. Despite the very encouraging data from ADP, we’ll need confirmation on Friday when the government is expected to show that employers added 140,000 new positions, per Bloomberg.

That’s up from a lackluster 39,000 in November, which came on the heals of a solid ADP report.  But after the outsized increase from ADP, many investors will be looking for another upside surprise, as government's number carries more weight when it comes to trends in job growth.

Jobless claims are in a downward trend and the number today suggests we may finally be entering a more self-sustaining phase for what so far has been a rather weak recovery.

If we get confirmation on Friday that the ADP figure was not a fluke, we may finally start to see a level of job creation that is needed to make a dent in an unemployment rate that stands near 10%.

ISM shows manufacturing moving along at decent pace

The Institute for Supply Management reported that the ISM Manufacturing Index increased from 56.6 in November to 57.0 in December.

Though just below expectations and not nearly as robust as the more volatile Chicago PMI, today’s number shows that manufacturing continues to expand at a healthy clip and impressive gains in production and new orders suggest further improvement early next year.



In its press release, the ISM noted, "The recovery centered on strength in autos, metals, food, machinery, computers and electronics, while those industries tied primarily to housing continue to struggle.

“Additionally, manufacturers that export have benefitted from both global demand and the weaker dollar. December's strong readings in new orders and production, combined with positive comments from the panel, should create momentum as we go into the first quarter of 2011."

Manufacturing has been and continues to be a bright spot in a tepid recovery that began in the middle of 2009.  The service sector, which makes up the bulk of economic activity, has lagged as the chart below indicates, though the sector has been expanding for about a year.  Wednesday’s release is expected to show another increase.



Recently, the bulk of economic indicators suggest that growth is accelerating, including today’s manufacturing report, a dip in weekly jobless claims below 400,000, recent gains in the Leading Economic Index and the strengthening stock market.

In addition, the just-extended Bush tax cuts, coupled with a partial payroll tax holiday, should aid the economy in the coming months.