Consumer Spending May Quicken In June
John Lonski, Moody's senior economist in New York
No change in monetary policy was no surprise to the investment community. Nevertheless, the
Federal Open Market Committee's (FOMC) press release warned against dismissing the
possibility of another interest rate hike by year's end. The FOMC believes that the probability of
rising inflation risks exceeds the likelihood of declining price pressures.
The latest slowing of US economic activity may not be severe enough to bring a quick end to
the latest episode of monetary tightening. Not only was the May estimate of total home sales
stronger than anticipated, but new orders for durable goods unexpectedly advanced by 6%
monthly in May which largely offset April's seemingly aberrant plunge of 5.7%. Motor vehicle
production also quickened considerably during June.
The Conference Board's index of US consumer confidence dipped from May's record high of
144.7 to a still very upbeat 138.8 in June. Despite several worrisome developments -- Federal
Reserve efforts to curb domestic spending, sharply higher gasoline prices, and May's reported
jump by the unemployment rate -- June's confidence index still topped its 138.3 average of the
12-months ended May and its 135.3-point average of 1999. In 2000's 2nd quarter, the
consumer confidence index averaged 140.4, which was second only to the 140.9 of 2000's 1st
quarter.
The quarter-to-quarter annualized growth of real consumer expenditures might drop from the
7.7% of 2000's 1st quarter to 3.2% for the 2nd quarter, which, in turn, should trim real GDP's
corresponding growth rate from 5.5% to 3.2%.
The US' first-quarter real GDP showed real consumer spending blasting higher by 5.9%
year-over-year. The latter was the steepest yearly increase since the 6.5% 1984's 1st quarter,
or when 1982's worst recession since the Great Depression afforded annual growth rates the
luxury of being measured off of a comparatively low base. For the 5 years ended 1999, real
consumer spending's annual increase averaged 4%.
For 2000's 2nd quarter, real consumer spending's year-over-year advance could sag to a still
impressive 5.4%. By 2000's final quarter, real consumer spending might still be up by 4.4%
yearly.
Real consumer spending grew by 0.2% monthly for a 3rd straight month in May. During the 4
months ended February 2000, real consumer spending averaged an impressive and
unsustainable monthly advance of 0.7%.
A drop in auto sales helped to lower real spending on consumer durable goods by 1.1%
monthly in May. After surging higher by 2.2% monthly, on average, during the 4 months ended
February 2000, real outlays on consumer durables have retreated by 1% per month, on
average, during the three months ended May
However, spending on consumer durables could recover in June according to a recent surge in
US motor vehicle production.
Following a 0.2% yearly dip in May, Ward's Automotive data suggests that US motor vehicle
production advanced by 10.2% yearly in June. If the automakers are closely adhering to
just-in-time inventory management techniques, then June sales of cars and light trucks might be
livelier than anticipated.
When motor vehicle output last posted a similar yearly increase in March 2000, the US'
private-sector nonfarm payrolls expanded by 374,000 new jobs.
Lending credibility to the weak reading on May's labor market was May's unchanged reading on
wage and salary income. By contrast, wages and salaries grew by 0.5% per month, on
average, for both 1999 and 2000-to-date. May recorded the worst month-to-month showing
since wages and salaries stalled in July 1996.
Reflecting May's loss of 116,000 private-sector jobs, private-sector wage and salary income
dipped by 0.1% monthly in May. Not since May 1995's 0.1% decline have private-sector wages
and salaries retreated from the previous month.
Nevertheless, the annual increase of wages and salaries edged up to the 6.8% of the
quarter-ended May. After most recently peaking at the 7.9% of 1998's 3rd quarter, the annual
growth rate of wage and salary income subsequently bottomed at the 6.4% of the
quarter-ended January 2000.
During the last 5 years, wage and salary income's 6.7% average annual increase supported a
6% average yearly gain for consumer spending. For the quarter-ended May 2000, consumer
spending's 8.3% annual increase instead outran the 6.8% climb of wages and salaries.
Consumer spending's yearly increase now descends toward the still brisk expansion of earned
income. An extended deceleration of wages and salaries would diminish prospects for both
household expenditures and the US economy.
Outlook Enhanced By Ample Confidence And Low Yields
High levels of consumer confidence suggest that household credit worth is more than adequate
for the purpose of assuring the efficacy of lower borrowing costs. Unless credit worth has been
significantly diminished, a decline by borrowing costs in response to slower expenditures ought
to spur an offsetting upturn by credit-sensitive outlays.
Extraordinarily high levels of consumer confidence should be incompatible with comparatively
weak household finances. Moody's consumer credit card delinquency rate was down from a
year earlier for a 27th consecutive month in May. Also, an index of mortgage applications for the
purchase of a home remains close to its record high despite sharply higher mortgage yields
both because of the health of consumer finances and because of above-average employment
security.
Consumer confidence remains steep enough to preserve the possibility of rejuvenated
household expenditures. For June-to-date, however, the major weekly surveys of retail chain
sales reported sales as generally being no better than plan.
To the degree the demand for US output no longer exceeds expectations, both new orders and
hiring activity may steady. Demand may no longer be racing past supply in a manner that
otherwise adds to inflation risks. However, some retailers detected a firming of sales during the
week-ended June 24th.
Consumer confidence's ability to power expenditures has been enhanced mortgage yields that
remain well under their highs of late-1994 and early-1995. Not since the late 1960s have
measures of consumer confidence been so high and Treasury yields so low.
According to the still steep price-to-earnings multiples of the broad equity market averages,
investors remain fairly confident about business prospects. A deep slide by consumer
confidence might be an early indication of a deterioration in earnings prospects that could
significantly depress price-to-earnings ratios. If worsening business prospects were to send P:E
ratios lower, the demand for labor services ought to slacken by enough to diminish consumer
confidence.
Investors need to be on guard whenever the upside potential for both consumer confidence and
P:E multiples has largely been exhausted. Lately, both consumer confidence and
price-to-earnings (P:E) multiples seem to have peaked.
CPI Inflation May Need To Top 4% To Sound Recession Alarm
Price inflation offers valuable insight regarding the nearness of a recession. Not until CPI
inflation breaks above 4% annually might the threat of recession become perceptible.
Six of the 7 recessions since 1955 were preceded by a marked upturn by CPI inflation -- the
only exception being the recession of 1960-1961. Going into the 1990-1991 recession, the
annual rate of CPI inflation climbed up from the 4.6% of year-end 1989 to the 6.2% year-end
1990. The annual rate of core CPI inflation also rose from the 4.3% of 1989's final quarter to the
5.4% of 1990's third quarter.
The previous two-part recession of 1980-1982 was largely in response to a steep ascent by the
annual rate of CPI inflation from the 5.1% of 1976's final quarter to the 14.5% of 1980's second
quarter. The Fed's failure to decisively confront inflation when it broke above 6% in 1977
probably contributed to the severity of the 1980-1982 slump.
Base Metals Prices Sag Despite Livelier Industrial Activity
Unlike year-to-year date price advances of 25% for crude oil and of 5% for agricultural
commodities, industrial metals prices have retreated by 2%. The industrial metals price index's
latest 20% year-to-year advance was down considerably from its 33% yearly increase of
early-March 2000.
The softness of industrial metals prices seems to be at odds with the livelier pace of global
industrial activity. For the quarter ended April, the industrial output of the 15-member European
Union (EU-15) expanded by 7.6% annualized from the quarter-ended January 2000, while
gaining 5.2% year-over-year. Elsewhere, US industrial production during the quarter-ended
May grew by 7.4% annualized from the quarter-ended February 2000, while advancing by 5.8%
yearly.
Part of May's surprisingly strong slowing by durable goods bookings might be credit to a
continued recovery by exports. Highlighting a slew of upbeat economic reports from abroad was
May's 7.5% year-to-year increase by Japanese industrial production. Also, for the
quarter-ended May, Japan's industrial output was up by an estimated 6.1% yearly.
The industrial output of the world's major developed countries -- the EU-15, US, and Japan --
advanced by an estimated 5.8% year-over-year for the quarter-ended May, for the steepest
such increase since the 6% of 1995's 1st quarter. Around that earlier time, the industrial metals
price index set a record monthly average of 538.0 in January 1995.
Although May's industrial metals price index of 503.3 was up by 23.6% annually, it edged lower
during June. An unchanged Fed policy might supply enough of a boost to world industrial
activity to firm base metals prices. If the industrial production of the major developed countries
accelerates, higher prices for industrial metals are practically inevitable.
Slower Spending Heightens Earnings Worries
An overestimation of corporate earnings should not surprise given the unsustainably rapid
advance of US domestic spending during year-end 1999 and the early part of 2000. Also
crimping profit margins are rising labor costs and the higher costs of certain industrial materials.
The employment cost index's annual rate of growth has already jumped up from the 3% of
1999's 1st quarter to the 4.3% of 2000's 1st quarter. First-quarter 2000's year-to-year climb by
the annual growth rate of the employment cost index was the steepest since the index averaged
a 1.2 percentage point advance in 1988. The annual change of US corporate profits from
current production would eventually plunge from 1988's +16.9% to 1989's -2.3%.
For 2000's 1st quarter, profits from current production grew by 8.9% annually, which was up
from 1999's year-long increase of 5.2%. When corporate credit rating upgrades outnumbered
downgrades and when the unweighted average of US stock prices grew by 10.8% annually, on
average, profits from current production grew by 13.1% annualized over the 5 years ended
1997.
For 1998-1999, profits from current production rose by merely 3.2% annualized. In turn,
corporate credit rating downgrades have outnumbered upgrades, the high-yield bond default
rate has been rising, and the unweighted average annual rise of US stock prices sank to 1.2%.
Since July 1998's global crisis, stock prices have averaged a yearly decline of 4.5%.
Market-value weighted stock price indices may not always capture changes in expected debt
repayment capacity. Credit market participants seem to be taking their cue more from June
28th's average 9.7% year-to-year drop for stock prices than from the 11.8% yearly increase for
the US equity market's overall valuation.
New Orders Imply Capital Spending Boom And Lively Profits
The demand for US-built capital equipment has risen sharply. Through the first 5 months of
2000, new orders for nondefense capital goods excluding commercial aerospace bookings grew
by 14.9% year-over-year, which more than doubled 1999's year-long annual increase of 7.1%.
The current year could slow the steepest annual increase for nondefense capital goods orders
ex aerospace since 1994's 14.8%, or when current-dollar business investment advanced by
9.7% in 1994 and by 10.2% in 1995. The annual increase of fixed business investment
spending slipped from 1998's 10.7% to 6.9% in 1999.
The record shows that corporate profits from current production should improve whenever the
annual increase of "impact" durable goods bookings climbs higher. After last bottoming at the
2.6% of 1998's 4th quarter, the annual increase of "impact" orders has since risen to the 9.1%
of the 3-months ended May 2000.
Since 1978, "impact" durable goods orders' average annual increase of 6% supported a 7.9%
average annual increase for profits from current production. Given the latest upturn by the
growth rate of "impact" durable goods orders, profits from current production should improve on
their 7.6% annual increase of 2000's 1st quarter.
Slower Debt Growth Could Trim Bond Yields
The slower growth of US nonfinancial sector debt has facilitated a decline by Treasury yields.
US nonfinancial-sector debt was up by 6.2% yearly as of April 2000, which was down from its
most recent 7% peak of April 1999.
In response to an acceleration of debt, Treasury yields should eventually climb higher as credit
demands rise more rapidly and as expectations of both real economic growth and inflation climb
higher. In conjunction with the uneven climb by the annual growth rate of nonfinancial-sector
debt from the 6.8% of year-end 1970 to its 16% zenith of year-end 1985, the 10-year Treasury
yield would eventually shoot up from the 6% of early 1971 to its 14.8% top of 1981's 3rd
quarter.
A subsequent plunge by nonfinancial-sector debt's annual rise down to the 4.3% of 1993's 1st
quarter would clear the way for an eventual bottoming of the 10-year Treasury yield at the 4.7%
of 1998's final quarter. A renewed upturn by the annual growth rate of the US' net indebtedness
from its early 1993 bottom has helped to push the 10-year Treasury yield back up to 6%.
April's 6.2% annual increase by the US' net debt consisted of a 3.1% drop by federal debt and
an 8.9% advance for non-federal debt. Credit worth considerations might eventually force a
slowing of nonfederal debt, which, when combined with a further contraction of federal debt,
would put downward pressure on bond yields. Suppose that over the 12 months ended April
2001, the annual increase of nonfederal debt slows to 6.5% while federal debt contracts by
another 2.5%. Those changes would have the US' total nonfinancial-sector debt grow by only
4.7% for the 12-months ended April 2001.
April's 6.2% annual increase by total US net debt was accompanied by a 6% 10-year Treasury
yield. In May, the Euro-zone's net debt rose by 7.6% annually and yet the EU-11's benchmark
10-year government bond yield averaged just 5.4%. Compared to the US, the EU-11's faster
debt growth and lower bond yields is an imbalance which favors higher euro-denominated bond
yields in the months ahead.
Debt's Deceleration May Curb Nominal GDP's Ascent
Nominal GDP rose by 7% annually during 2000's first quarter, for its steepest such increase
since the 7.3% of 1989's 3rd quarter. The annual increase of nominal GDP could approach
7.5% in 2000's 2nd quarter.
The recent nearly 6% 10-year Treasury yield was at the deepest discount relative to nominal
GDP's annual growth rate since 1998's final quarter, or when the 4.7% 10-year Treasury yield
trailed nominal GDP growth by 1.2 percentage points. Thereafter, a livelier economy would
drive the 10-year Treasury yield up to its 6.5% of 2000's 1st quarter.
If the US economy re-accelerates, Treasury debt buybacks may not be enough to prevent the
10-year Treasury yield from quickly adding on another 50 basis points. Consider how during the
5 years ended 1999, the 6.1% average of the 10-year Treasury yield averaged half of a
percentage point more than nominal GDP's 5.6% average annual increase.
The annual growth rate of nominal GDP has taken direction from the annual change of
nonfinancial-sector debt. If the latest slowing of nonfinancial-sector debt were to continue,
nominal GDP might also eventually slow.
The 5.6% average yearly increase of nominal GDP for the 5 years ended 1999 was joined by a
5.9% average annual increase for total nonfinancial-sector debt.
A drop by the annual increase of total nonfinancial-sector debt from 1985's record 16% to
early-1993's 4.3% was accompanied by a drop in nominal GDP's year-over-year growth rate
from 1984's 11.35 to 1991's 3.2%. A pronounced deceleration of nominal GDP can significantly
erode debt repayment capabilities.
A subsequent climb by nonfinancial-sector debt up to its 7.2% annual increase of September
1999 facilitated a rise by nominal GDP's annual growth rate to the 6.1% of the year-ended
March 2000.
The annual increase of private-sector net debt has already slowed from September 1999's
13-year high of 10.6% to the 9.8% of March 2000. A further slowing of private-sector debt
would probably help to push nominal GDP's annual increase back under 7%. Such a
development might lessen both interest rate risks and credit risks.
During the 5-years ended March 2000, private-sector net debt's average annualized growth rate
was 8.4%, which was still well under the 11.9% peak of the 5 years ended June 1988.
Housing Largely Withstands Higher Interest Rates
Forecasts calling for a 7% federal funds rate implicitly assume that the latest slide by fixed-rate
borrowing costs will reinvigorate domestic expenditures. The 30-year mortgage yield's monthly
average dropped from May's 8.52% to a prospective 8.23% for June. The latest dip by the
30-year mortgage yield may help to prevent a deep slide by housing activity.
May's sum of new and existing home sales rose by 3.6% monthly and gained 0.7% yearly, but
lagged its 12-month trend by 1%. For the quarter-ended May, the 2.3% annual decline by total
home sales differed considerably from the 11% yearly increase of mortgage applications for the
purchase of a home.
For the quarter-ended May, total home sales fell to their lowest level on record compared to
homebuyer mortgage applications. Total home sales last fell noticeably relative to homebuyer
mortgage applications during the 3-months ended November 1998. Home sales would prosper
thereafter and establish an all-time high by mid-1999. Although another surge by home sales is
unlikely, the relatively steep readings for mortgage applications from potential homebuyers
suggest that the current deceleration of housing activity may lack the severity of 1995's
slowdown.
May's 4.3% monthly jump by existing home sales to an above-trend, seasonally-adjusted pace
of 5.09-million annualized units suggested that credit sensitive spending need not soon
collapse. May's adjusted tally for existing home sales eclipsed its lagging 12-month average by
0.4%.
New home sales in May slipped by 0.2% from a downwardly revised April estimate to 875,000
annualized units. May's sales pace fell by 2.3% yearly and trailed its lagging 12-month average
by 3.9%.
May's unsold supply of new homes rose by 5.6% yearly. The inventory-to-sales ratio of newly
built homes was at 0.37:1 in May, which was up from its 0.34:1 average of the previous 12
months, but well under its 0.58:1 average of 1995's 1st quarter, or when housing activity last
suffered a rate-inspired slump.
Japan's Jobless Rate Drops
Japan's May unemployment rate of 4.6% was unchanged from a year earlier. After rising
year-to-year for each of the 32 months ended March 2000, Japan's jobless rate has matched its
year ago mark for 2 consecutive months. May's number of unemployed Japanese fell by 1.8%
yearly -- the first such year-to-year drop since April 1997.
Despite the year-to-year dip in unemployment, the demand for labor remains flat according to
May's 0.4% yearly drop in Japanese employment. Still, after a long string of declines, the
nonfarm payroll subset of total employment managed to rise by 0.6% yearly in May.
A continued deficiency of labor demand relative to those seeking employment was implicit to
May's 0.56:1 ratio of Japanese job offers per job seeker. Although this ratio was up from its
record 0.46:1 low of May-August 1999, Japan's excess supply of labor persists. Nevertheless,
Japan's ratio of job offers per job seeker has entered into its first upswing since 1994-1996.
Japan's unemployment rate recently peaked at the 4.9% of February-March 2000. A firming of
the labor market would be constructive for Japan's household expenditures. One measure of
Japan's real household spending fell by 1.2% yearly in May. For the quarter-ended May, this
barometer of real consumer spending edged higher by 0.4% annually.
Japan's housing starts have yet to break higher in a manner that indicates a decisive return to
economic normalcy. May's housing starts were off by 1.1% yearly. For the quarter ended May,
Japanese housing starts contracted by an estimated 4% annualized from the quarter ended
February 2000, while slipping by 1.5% year-over-year.
The annual rate of decline for Japan's CPI narrowed from November 1999's 1.2% to May
2000's 0.7% Japan's core CPI for May was off by 0.2% annually.
More Good Economic News From Europe
US exports to Europe ought to expand more rapidly throughout the remainder of 2000. The
exports of the 15 member country European Union (EU-15) advanced by 19% year-over-year
for the quarter ended April 2000, while the EU-15's imports surged higher by 28% annually. By
contrast, US merchandise exports to Western Europe grew by a much flatter 6.6% annually for
the quarter-ended April, wherein exports to the Euro-zone, or the EU-11, gained 4% annually.
For a 31st consecutive month, France's unemployment rate was down from a year ago. May's
French jobless rate of 9.8% was well under the 11.3% of a year earlier and was the lowest
since January 1992's 9.8%. May's 17% year-to-year plunge in the number of unemployed
French has helped to invigorate household expenditures.
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John G. Lonski, chief economist |
