A lot of economic puzzle pieces came out last Friday that seem to indicate the U.S. economy is improving. Taken separately, the pieces look encouraging. But when you join them all together, they don’t compose such a pretty picture.
In particular, there were two key pieces of data in the set that may prompt the Federal Reserve to begin reducing its monthly bond buying in December. Couple that with the ugly big picture and markets could be in for a tumble before the year is out.
Taken Separately – Things Look Good
The most encouraging single piece of data that came out last Friday was consumer spending, which rose 0.3% in August, better than July’s 0.2% increase. That’s good enough to keep the nation’s GDP growing at a healthy 2% to 2.5% annual rate, Paul Ashworth of Capital Economics estimates.
Where has this extra spending money come from? Well, that’s the second most encouraging piece of the economic picture that came out on Friday – an increase in wages. Incomes rose 0.4% in August, twice the growth of July’s 0.2% increase. That private income growth of 0.5% beat government income growth of 0.2% is also a good sign, indicating that the real economy is still growing despite the government’s sequester of spending. Although one can only wonder how much more that growth would have been without the cuts.
Analysts including Ashworth expect the higher wages to feed back into consumer spending. “The pick-up in income growth in August suggests that consumption growth may even accelerate in the fourth quarter,” Ashworth predicted to Reuters.
A third happy piece of data came in a reduction of people seeking unemployment benefits to the lowest amount in six years. This leads economists to expect a strong employment number this Friday of some 200,000 new jobs created in September.
Lumped Together – Not So Pretty
But what makes the economic picture look a little drab are the causes and the effects of those nice numbers noted above.
Consumer confidence, as measured by the Thomson Reuters University of Michigan Consumer Sentiment Index, dropped to 77.5 in September from 82.1 in August, which was itself down from 85.1 in July. In fact, it is now at its lowest level in five months.
Worrying consumers are the gridlocks in government over important budget issues, including the looming credit limit and the ongoing sequester. So worried are they, in fact, that Americans have increased their savings, with the personal savings rate rising to 4.6% of after-tax income in August, up from July’s 4.5% savings rate.
So if consumers are less confident and have thus turned to saving more, perhaps the higher consumer spending was not caused by something positive like growing economic activity or increased sales volume. Maybe there was something else behind the higher consumer outflow… inflation.
Core inflation – which excludes the more volatile food and energy prices – rose to 1.2%, increasing by 0.2% in August, higher than July’s 0.1% increase. And this could spell trouble ahead.
Walmart (NYSE: WMT) is expecting a Grinchy holiday shopping season this year. With unsold merchandise collecting dust on its shelves, the largest discount retailer in America is reducing its orders with suppliers – not just for Q3 but also for Q4 – warning that this year’s shopping season will be the worst since 2009. The retail chain cites inflation as one of the culprits stealing this year’s holiday cheer.
Barclays (NYSE: BCS) economist Peter Newland seems to be expecting a dismal year-end as well, noting that his bank has not changed its annualized GDP estimate of 1.7%, which is much lower than the current 2% to 2.5% annual rate.
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Markets Might Meander
Millan Mulraine, an economist at TD Securities, indicated to Reuters that “this acceleration in core inflation will likely be encouraging to the Fed.”
The Federal Reserve, which has been debating when to begin reducing its monthly bond purchases, has long indicated it wants to stimulate inflation in the economy at an annual rate of 2%, allowing for as much as 2.5% to make up for some lost years of growth. Although the latest inflation figure is still well below the Fed’s target, the number’s recent rise strengthens the case for a slight taper in December.
If last month’s drop in people seeking unemployment benefits leads to a robust jobs report this Friday, the case for Fed tapering would strengthen all the more, since strong employment data is a second key statistic the Fed looks to for direction.
From all three sides, then, investment markets may begin to unravel a bit – first from government gridlocks in credit ceiling talks and budget issues, second from an expected slowdown over the holiday season, and third from an ever growing case for a Fed bond taper.
Look for some sideways meandering within the equity markets, with 5% to 10% swings down and up – which have already occurred twice since May – to continue into the new year. It’s a trader’s market now, buying on the dips and trimming profits on the crests.
Joseph Cafariello
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