Consumers Still Spending and Outpacing Income Growth. Sustainable Trend?

This morning, consumer spending rose 0.6% in September, more than the 0.4% gain expected according to?Bloomberg, and following a similar rise in August.

Personal income, meanwhile, rose 0.4% in September, as expected and also following a similar gain in August. Year-over-year, consumer spending increased 8.2% and personal income rose 5.2%.

Adjusting for inflation, real consumer spending rose 0.3% for the second consecutive month, while real income was flat in September, down from a 0.2% gain in August. Over the past 12 months, real spending rose 1.9%, the weakest annual gain since February 2021, while real income fell 1.0%, the ninth consecutive month of decline.

The PCE rose 0.3% in September, as expected. Year-over-year, headline inflation increased 6.2%, following a similar rise in August and still near a four-decade high.

Excluding food and energy, the core PCE rose 0.5% in September, also as expected. Year-over-year, core inflation increased 5.1%, up from the 4.9% annual increase last month.

Bottom Line:?Consumers are still spending, albeit at a markedly reduced pace.?Lower gas prices and renewed state and local stimulus in more than a dozen states or major cities, not to mention an increased willingness to eat through remaining savings and ramp up debts, has aided in supplementing or sustaining consumer spending,?at least in the near term. Going forward, however, rising prices and negative real income growth will compound pressure on the consumer and presumably result in even slower activity, a difficult prospect for a consumer-based economy,?not to mention businesses ahead of the key holiday shopping season.??

This morning’s data highlighting growing weakness in part of the consumer and still elevated inflation follows yesterday’s unexpectedly solid GDP report, at least on the surface.

Yesterday, GDP rose 2.6% on an annualized basis in the third quarter, following a 0.6% drop in the second quarter. According to?Bloomberg, activity July to September year was expected to rise 2.4%.

In the details, personal consumption rose 1.4% in Q3, down from a 2.0% increase in Q2.

Goods consumption, however, fell 1.2%, due to a 0.8% decline in durable goods consumption and a 1.4% drop in nondurable goods consumption.

Services consumption, on the other hand, increased 2.8%, down from a 4.6% gain in Q2.

Gross private investment, a gauge of business spending, dropped 8.5% in Q3, following a 14.1% drop in Q2.

Fixed investment fell 4.9% in the third quarter, following a 5.0% decrease the quarter prior.

Nonresidential investment, including office buildings and factories, rose 3.7%, due to a 10.8% rise in equipment investment, and a 6.9% gain in intellectual property investment. Structures investment, however, fell 15.3% in Q3.

Additionally, residential investment plunged 26.4%, the largest decline since Q2 2020.

On the trade side, exports rose 14.4%, while imports declined 6.9% following a 2.2% gain the quarter prior.

Finally, government consumption rose 2.4%, following three consecutive quarters of decline. Federal spending rose 3.7%, nondefense spending increased 2.3%, state and local spending gained 1.7%, and national defense spending increased 4.7% in Q3.

The PCE deflator, meanwhile, rose 4.1% in the third quarter, less than the 5.3% gain expected and down from the 4.7% gain in the second quarter.

Bottom Line:?While a welcome reprieve after six consecutive months of negative activity at the start of the year, the bump in third-quarter growth is likely a temporary boost rather than an indication of sustainable upward momentum. Already the latest data suggests the consumer is pulling back further heading into the final quarter with business investment and housing also slowing more precipitously.

Nevertheless, from the Fed’s perspective, yesterday’s report is a sizable feather in the Fed’s cap to continue along with a more robust pace of tightening as the Committee remains focused on reinstating price stability.

Also this morning, the latest central bank announcement from the Bank of Japan (BOJ) shows at least some central banks are taking a less aggressive approach to tackling inflation. The Bank of Japan, as expected, left its policy unchanged with its key lending rate at -0.10% as it has been since 2016. Coupled with the latest policy announcement, PM Fumio Kishida also announced a ￥71.6 trillion ($490 billion) stimulus package including private contributions and other fiscal measures. The package is aimed at easing the impact of rising prices as well as boosting growth by reducing energy costs, with the package estimated to save the average household about 45,000 yen next year.

Japanese inflation rose 3% in September following a similar gain in August and marking an eight-year high. GDP in the country, meanwhile, rose 3.5% in the second quarter, up from the 0.2% gain in the first quarter and a two-quarter high.?Thus, the combination of relatively lower prices and stronger growth compared to much of the developed world has afforded the BOJ increased flexibility other central banks are not able to enjoy.

The BOJ decision comes on the heels of more significant policy action elsewhere around the world.

On Wednesday, for example, the Bank of Canada (BOC) raised rates for the sixth time in eight months. The BOC surprised the market with a 50bp hike instead of a 75bp hike, bringing the key lending rate from 3.25% to 3.75%.

Yesterday, the European Central Bank (ECB) raised rates by 75bps, lifting the deposit rate from 0.75% to 1.50%, the highest since 2008. Recall, the ECB initiated rate hikes in July. Inflation in the region, however, has already surged past 10%, compounding pressure on policy makers to continue to take strong action against price pressures despite increased evidence of mounting weakness in the economy.

Aside from raising rates, the central bank is also actively discussing ways to reduce its balance sheet holdings, which have grown to €8.8T, or roughly 70% of Eurozone economy. According to the statement,?"In view of the unexpected and extraordinary rise in inflation, it (TLTRO) needs to be recalibrated to ensure that it is consistent with the broader monetary policy normalisation process and to reinforce the transmission of policy rate increases to bank lending conditions.”

Going forward, as the ECB continues to face rapidly rising prices, policymakers are, like the Fed, focused on taming inflation. Policy officials overseas, however, have also indicated a relatively stronger level of concern over a decline in economic activity, a divide which will presumably widen following yesterday’s positive growth report in the U.S.

Next week, the Federal Reserve is poised to continue on the pathway to higher rates with a fourth-round 75bp hike nearly fully priced into the market. Of course, the bigger question is where does the Fed go from here? With investors and market participants consistently getting?“surprised to the upside”?by inflation, as Minneapolis Fed President Neel Kashkari noted last week, and nominal price levels still near a four-decade high, against the backdrop of a still solid labor market and a stronger-than-expected rise in third-quarter activity, it’s hard to see a need for the Fed to reduce the size of rate hikes just yet. That being said, there are some policy makers that are anxious to slow policy in order to better assess the impact of the five earlier rate hikes.

Aside from the policy announcement itself the market will be looking at statement wording. Keep in mind, one of the key phrases that investors will be searching for is?“ongoing rate increases would be appropriate.”?While the FOMC is expected to maintain this guidance, a softening of this language should indicate the Fed is willing to pivot to a softer stance against inflation. Additionally, the September statement noted?“modest growth.”?Again, we do expect the Fed to maintain this language particularly against the backdrop of a 2.6% rise in Q3 GDP, however, should the Fed deviate from this language, suggesting growth has softened or alternatively that economic activity has picked up, market expectations will be adjusted accounting for a smaller or more aggressive policy action, respectively, at year-end.?

Additionally this morning, pending home sales plunged 10.2% in September, more than the 4.0% decline expected and following a 1.9% decrease in August. Over the past 12 months, pending home sale fell 30.4%, the tenth consecutive month of decline.

Finally this morning, the University of Michigan Consumer Sentiment Index unexpectedly rose slightly from 59.8 to 59.9 in the final October reading, a six-month high. According to?Bloomberg, the index was expected to decline to 59.6 in the final print. In the details of the report, a gauge of current conditions was revised higher from 65.3 to 65.6, also a six-month high, while a gauge of future expectations was unrevised at a reading of 56.2 in the final October print.

Next week, the economic calendar begins with the Chicago PMI and the Dallas PMI on Monday.

On Tuesday, the S&P Global Manufacturing PMI and ISM Manufacturing Index will be released. While slightly different gauges of varying regional and national activity, the conclusive trend has been to the downside. While still mostly positive activity, the momentum has clearly slowed as production responds to a pullback in consumption. Again still positive, but the indexes are showing a second derivative decline or a slower pace of still-positive activity.?

Also on Tuesday ahead of Friday’s jobs report, we will take a look at the September JOLTS reading, or the Job Openings and Labor Turnover Survey. Down from a recent peak of 11.9M in March, labor demand remains elevated with 10M open positions in the marketplace, far outpacing the number of able bodies willing to come back into the market to fill the existing job vacancies.?

On Thursday, there will be a shift from goods to services activity with the latest October ISM services report. Services activity, like manufacturing, remains positive but has lost significant momentum, slowing from a peak reading of 68.4 in November 2021 to 56.7 in last month’s report. Activity is expected to slow further in October to just 55.5, a four-month low.

Also on Thursday, another weekly jobless claims report will be released. Claims rose 3k from 213k to 217k in the most recent report, a two-week high.

As previously mentioned, on Friday the key jobs report will be released. October nonfarm payrolls are expected to rise 200k, down from the 263k rise in September. The unemployment rate is expected to tick up a tenth of a percentage point to 3.6%, and average hourly earnings are expected to rise 0.3% in October and 4.7% over the past 12 months.

-Lindsey Piegza, Ph.D., Chief Economist?