Consumer spending, incomes up in March

Recovery not stalling

A rise in consumer spending and higher personal income last month is helping to alleviate some of the worries that economic activity is slowing too quickly.

The government reported this morning that consumer spending increased 0.6% in March, while personal income gained 0.5%.  That follows an upward revision to February’s numbers, including a robust 0.9% rise in spending in February.

Inflation continued its upward March, as higher oil and food prices pushed up the PCE Price Index by 0.4%, matching February’s rise.  The core rate of inflation, however, slowed, increasing just 0.1% last month and held at 0.9% year-over-year.

Given the overall rise in inflation, real spending, which takes into account the change in prices, was up a modest 0.2% after moving ahead a respectable 0.5% in the prior month.

The savings rate held steady at 5.5%.

The improvement in income is being aided by increased employment, which in turn is helping to support consumer outlays and taking some of the sting out of higher gasoline prices.

Further, the upward revision to February seems likely to provide modest support to GDP when the figure is revised next month.

But weekly jobless claims have turned higher.  Assuming the disquieting upward shift in claims is not coming from statistical noise that seasonal adjustments are failing to capture, it does seem appear the economy is slowing somewhat.

We’ll get more when the ISM service and manufacturing reports are released next week.

Still, March’s rise in spending suggests the recovery is not stalling out.

Consumer sentiment stabilizing

The University of Michigan’s survey of consumer sentiment tumbled in March amid the uncertainty generated by events in Libya, surging gasoline prices and the earthquake in Japan.

But the closely-followed Consumer Sentiment Index managed a small rise this month, increasing from 67.5 in March to 69.8 in April, suggesting some stability in consumer confidence.

Inflation continues to be a concern but longer-term fears appear to be easing.

Reuters said the one-year inflation expectation was unchanged at 4.6%, the highest level since 2008. No doubt that gasoline prices are heavily influencing the short-term outlook.

But the 5-to-10-year inflation outlook fell to 2.9% from 3.2% the month before, which reveals that consumers and bond holders alike still believe the Fed has not lost its ability to keep price hikes under control (see chart from WSJ below).

That bodes well  for the economy since consumers have been squeezed by the pain at the pump, and it has to come as a relief to policymakers at the Federal Reserve who have been wrestling with a sluggish economy, surging commodity prices and a modest bump in core inflation.

Weaker GDP growth based on a number of factors

GDP advanced at a respectable 3.1% annualized pace in Q4 but slowed considerably according to advanced data provided by the U.S. Commerce Department, growing just 1.8% in Q1.

Real final sales, which measures GDP less changes in private inventories, increased a scant 0.8%, versus a robust 6.7% in the final three months of 2010.

The table below looks at key components of GDP and how they contributed to or detracted from the economy last quarter and in Q4 per government data.

As an example, consumer spending contributed 2.8 percentage points to the 3.1% rise in GDP in Q4 and 1.9 percentage points in Q1. Weakness in other components translated into growth of just 1.8%.

	Q4’10	Q1’11
GDP	3.1	1.8
Consumer Spending	2.8	1.9
Change in Inventories	-3.42	0.93
Exports	1.06	0.64
Imports	2.21	-0.72
Govt. Spending	-0.34	-1.09
Residential construction	0.07	-0.09

The huge swing in inventories lent support to GDP in Q1, as companies lifted output following a big drawdown in Q4, but a large rise in imports detracted from overall economic performance.

Diminished consumer confidence and rising gasoline prices also appeared to pressure consumer spending despite the payroll tax cut that was enacted by Congress late last year.

Housing’s diminished role in the economy had very little impact (see Housing – losing its importance as economic driver).

Today’s report is not the final say on growth last quarter, as we have two more revisions that will incorporate updated information on trade, inventories and spending.

If there is a silver lining to today’s report, the outsized jump in imports played a key part in the feeble GDP number, but one can’t discount the anxiety consumers are feeling.

Needless to say, Q1 was a disappointment and is a stark reminder that a recovery that follows a recession caused by a financial crisis is typically slow and uneven.

Unfortunately, the uptick in weekly jobless claims and recent modest gains in the bond market suggest the slowdown is continuing into Q2.  Strength in the stock market, however, suggests the weakness we are seeing is temporary.

Weekly jobless claims at three-month high

Weekly jobless claims unexpectedly jumped from 404,000 in the prior week to 429,000, the third consecutive week above 400,000 and the highest level in three months.

The 4-week moving average increased by 9,250 to 408,500, and continuing claims fell 68,000 to 3.64 million.

GDP in Q1 expanded by 1.8% according to preliminary data, and given the unexpected rise in jobless claims over the past three weeks, it appears that the slowdown in economic activity is continuing into Q2.

Oil has risen by about $20-25 per barrel in recent months to just over $110 per barrel but remains well below the all-time high of $145.  Gasoline prices, however, have surged by about a $1 per gallon in the last year and are hovering near the high hit in 2008.

Whether the slowdown is directly related to the spike in gasoline prices or the glitches in the supply chain caused by the earthquake in Japan, the unexpectedly large rise in jobless claims over the past three weeks is disconcerting.

It not only points a further slowing in the recovery, but it may also be signaling fewer gains on the employment front.

Fed still transitory on spike in inflation

The Fed was pretty clear where it stands on the recent spike in inflation from extremely low levels.

In its statement, the FOMC said: “Commodity prices have risen significantly since last summer, and concerns about global supplies of crude oil have contributed to a further increase in oil prices since the Committee met in March.  Inflation has picked up in recent months (a new addition to the statement), but longer-term inflation expectations have remained stable and measures of underlying inflation are still subdued.

The Fed added, “Increases in the prices of energy and other commodities have pushed up inflation in recent months.  The Committee expects these effects to be transitory.”

It’s the publicly stated belief that higher gasoline and other commodity prices won’t stoke a new round of unwanted inflation which pushed the dollar down and gold and silver prices higher in late afternoon action.

Traders believe that Bernanke is not taking a hard enough line on surging commodity prices.

But wage gains remain stable and there’s still some slack in the economy, and that does give the Fed some leeway.

Moreover, Bernanke’s focus is on the tepid pace of the economic recovery, and a hawkish shift in the Fed’s stance is unlikely as long as unemployment remains high and job creation does not substantially accelerate.

Given a ten-year Treasury yield that is below 3.40%, the bond market is more in sync with the Fed, even if gold and the dollar are not.

Still, there are always risks to the outlook, and Bernanke is willing to gamble on an uptick in the core rate of inflation if it means a more robust recovery.

Fed boosts inflation forecast, cuts GDP

Bernanke points to end of QE

The first take on the Fed’s rate decision and economic outlook is available in my piece, Fed holds steady, tweaks outlook on economy. But in conjunction with Ben Bernanke’s first press conference, the Fed released its outlook on the economy, lifting its view on inflation and cutting the outlook on GDP growth.

Below is a look at economic projections released today by the Federal Reserve for GDP, unemployment, headline inflation and core inflation.


 (click to enlarge)

Despite its latest take on inflation, the Fed still believes the impact on inflation will be “transitory,” as wages, the biggest input cost to most businesses, have been stable, and there is still some slack in the economy.

Q&A
QE2 - no tapering off; the Fed will just let the program end in June, and he doesn’t expect much of a disruption in the financial markets since the central bank’s intentions have been well telegraphed.

Because inflation has picked up somewhat and inflation expectations are a little higher, trade-offs for a third round of quantitative easing are less attractive at this point. Translation: QE3 looks unlikely amid the spike in gasoline prices.

Other sound bites from Bernanke in his press conference:

His interpretation of “extended period” in the statement goes out two meetings, but it is also used simply because uncertainty is a part of every economic equation.

The Fed cut its GDP forecast based on an expected weak Q1 GDP number, which it also believes will be transitory.

The Fed is carefully watching gasoline prices, but rising oil demand has been mostly confined to emerging markets and U.S. demand is down. Consequently, the Fed has little control over the price of oil.

Bernanke supports a stable dollar, and the recent decline is mostly due to an unwinding of safe-haven buys. Still, he didn't talk much on the importance of a strong dollar, suggesting that a stable and strong dollar is not high on the Fed's list of priorities.

Looking ahead, the Fed plans to maintain the level of securities on its balance sheet and re-invest maturing securities, something I alluded to yesterday when I previewed today’s report.

Bernanke said that not re-investing the proceeds of maturing securities would shrink the Fed’s balance sheet and would be correctly construed as tightening.

Asked whether the Fed's monetary policy might provide the future tinder for inflation, Bernanke believes the Fed will tighten at the right time and not stoke unwanted inflationary pressures by easing for too long a period.

On the deficit, Bernanke said addressing the spending and revenue gap must be a top priority.

Asked if the public is expecting too much from the Fed given that recessions sparked by a financial crisis are slow, Bernanke looked at past policy mistakes, including a slow recapitalization of banks. And he focused on factors that are specific to this recovery, including housing and high gasoline prices.

He sympathized with the public's impatience but does expect growth to gradually accelerate though he did not provide specific remedies for accomplishing his goals in the short term.

New home sales rebound from record low

New home sales totaled a seasonally adjusted annual rate of 300,000, representing an 11.1% rise from an upwardly revised 270,000 in February, suggesting that calmer weather may have provided a mild tailwind for home builders, as sales rebounded from their lowest level since records began back in 1963.



Based on current sales, the supply of homes for sales fell from 8.2 months in February to 7.3 months in March.

The actual number of new homes for sale slipped by 2,000 to 183,000, the lowest number since August 1967 when a record low of 181,000 homes were available, according to government data.



Of course, the U.S. population is much greater than it was over 40 years ago, and the lack of available supply may lend support to the market when sales eventually rebound.

Builders are not where they would like to be but they have been able to reduce the supply of homes on the market that are based on current sales from a peak of over 12 months in early 2009 to a more sustainable range.

Still, the lack of actual supply, which might normally be a plus for the market, is being offset by a number of factors at the current time.

Builders continue to compete with distressed sales and a shadow inventory of late model homes that are being held in foreclosure.

Traffic is a key driver for housing starts, and visitors at model homes are down sharply from the levels seen when the market was much stronger.

Many who have been forced from their houses are finding shelter in rentals and have little desire, or the financial resources, to purchase another home at this time. And the general lack of confidence potential buyers have in the housing market is also a headwind to sales.

The rebound in March shouldn’t be dismissed as it suggests the new home market is not headed to new lows, but sales continue to meander along the bottom without any concrete signs of a new burst in activity (see Home builder sentiment languishes).