Consumers Less Enthused to Bail Out the Economy

Markets Mixed in Quiet Week

Equity markets were mixed last week, as the S&P 500 rose 0.3% and the Dow Jones Industrial Average declined 0.1%. The S&P 500 has posted positive gains in every week of 2013 thus far. Some believe the blizzard wreaking havoc on the Northeast late Friday impacted markets, as stock volumes fell to their lowest levels of the year.

The Bank of England and European Central Bank both held meetings last week, but yielded little in the way of new policy. Barclays Research noted that ECB President Mario Draghi did strike a more dovish tone to convince the markets that policy would remain accommodative for an extended period of time. There had been some debate on this topic following the early repayment of some three-year LTRO loans.

The US dollar rallied sharply against the Japanese yen last week following the announcement that Bank of Japan Governor Masaaki Shirakawa would step down three weeks earlier than his term expiration on April 8. Given Japanese Prime Minister Shinzo Abe’s calls for aggressive easing policies, it appears likely the central bank will be headed by someone who shares a similar perspective. Some analysts expect a more aggressive policy stance as soon as the Bank’s next meeting.

It was a quiet week on the economic front, with only a handful of important releases to digest.

On Tuesday, the Institute for Supply Management (ISM) reported that its non-manufacturing index slipped 0.5 points to 55.2. This remains solidly in expansionary territory, however, the 37th straight month of expansion.

The underlying components were mixed, with the majority showing accelerating growth. However, a softening in the all-important new orders index weighed on the headline index. Despite the slow down, new orders remain expansionary. ISM noted that “respondents' comments are mixed about the economy and business conditions; however, the majority of respondents are optimistic about the overall direction.”

The service sector appears to remain healthy. Although manufacturing exhibited a period of softness in mid-2013, non-manufacturing indices have generally been more resilient. This is yet another encouraging sign for the US economy.

Consumer credit grew $14.6 billion in December, continuing a run of robust increases in the series. Unfortunately, consumer debt is mostly being generated by student loans and, to a lesser extent, auto loans. Credit card debt, on the other hand, as representing by revolving credit, remains tepid. The measure fell $3.6 billion during the month. Consumers appear to remain hesitant about increasing their debt loads for all but a few sectors of the economy.

One of the more surprising readings of the week was the sharp drop in the US trade deficit. An increase in exports and decline in imports led to a more than 20% contraction in the trade balance. In December, the deficit fell from $48.6 billion to $38.5 billion. This was partially a normalization following last month’s wider gap driven by iPhone imports.

The trade gap in petroleum goods declined as imports of crude oil declined in the month. Some economists believe this a transient phenomenon, indicating the trade deficit may see some volatility in the months ahead. Exports of industrial supplies and civilian aircraft showed the most strength in the month.

Consumers Less Enthused to Bail out The EConomy

Following recent recessions, it was commonplace to rely on American consumers to bail out the economy. The reliance on the American consumer was widely understood as the “best” remedy for an ailing economy. We are not as fortunate this time around and our dependence on consumers is one reason for the sluggish rate of recovery since 2008.

The Federal Reserve Bank of St. Louis recently released a research report entitled, “Don’t Expect Consumer Spending to Be the Engine of Economic Growth It Once Was.” Detailed throughout the report was analysis that consumers are no longer in as strong a position to support the economy.

Dating back to the late 1970s, consumer spending as a share of overall gross domestic product (GDP) grew considerably, rising from 62.5% in 1977 to 69.5% by 2007.

Personal Consumption Expenditures (PCE) as Share of Gross Domestic Product:.

Source: Federal Reserve Bank of St. Louis

That growth came on the heels of an unusual period of globalization, which allowed American consumers to import consumer goods at a 3.5% rate in the 25 years leading up to 2008. That proved faster than the rate of GDP growth during the same period.

Today’s environment holds certain similarities, but many stark differences as well. Personal consumption expenditures were up 3.6% in 2012, nearly identical to the 25-year growth rate prior to 2008.

Source: Federal Reserve Bank of St. Louis

Even the fourth quarter GDP report, which was weak on the surface, showed surprising consumer strength. In fact, consumer spending contributed 1.5% to overall GDP.

Source: Washington Post

Consumers have also been able to reduce their debt loads, as seen in the debt services ratio (DSR). The DSR recently crossed below 11% and sits at levels last experienced in the mid-1990s.

Source: Federal Reserve Bank of St. Louis

The challenge is in what the future holds. For one, the 2% payroll tax cut was not extended, much to the chagrin of consumers. The University of Michigan Index of Consumer Sentiment, for instance, fell from 82.7 in November to 73.8 in January.

Additionally, fiscal policy is likely to play a role in dampening economic growth and consumers’ mood throughout 2013.

Goldman Sachs anticipates the drag from fiscal policy will amount to as much as 2.5 percentage points of GDP in the second quarter. Sequestration cuts, which are scheduled to begin March 1, will cut 0.6% from GDP and impact government agencies across the country.

Source: Goldman Sachs

Credit has arguably been a tailwind for consumers, with consumer credit outstanding having risen 5.7% in 2012 but virtually all of that increase occurred in the non-revolving credit category, which jumped 8.3% relative to a 0.3% increase in revolving credit.

At initial glance, even consumer incomes looked strong in December, but it was quickly realized that most of the uptick was special dividends and bonus payments being paid in advance of higher tax rates. Rather than pumping that money back into the economy, consumers chose to save, pushing the personal savings rate from 4.1% to 6.5%.

Source: Federal Reserve Bank of St. Louis

The St. Louis Fed summed it up best when they said there are five headwinds consumers are currently encountering: lower wealth, flat incomes, tighter credit standards, weak confidence, and the pending withdrawal of stimulus. Until those headwinds abate, consumers are unlikely to be a savior of domestic and global economic growth.

the week ahead

Economic data picks up next week with new reports on retail sales, small businesses, and industrial production. Consumer sentiment is also due on Friday.

In Europe, there are several important meetings taking place this week, including the Eurogroup meeting on Monday and the Ecofin meeting (European finance ministers) on Tuesday. GDP growth estimates for the Euro area are also due for release.

Central banks from Indonesia, Russia, Sweden, Japan, and Chile provide updated rate guidance this week.

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