Tim Duy with a Fed Watch. Tim sent this to me yesterday, but due to travel I am only now getting it posted:
Heading into the Holiday Shopping Season, by Tim Duy: So much data, so little time. There never seems to be enough time to fully dig into each data release, leaving me always a little behind by the end of the week or, in this case, two or three weeks. As a form of catch-up, I thought some comments on the consumer were particularly appropriate, just two days before Black Friday.
But for the consumer, I need to start with housing. Last time I wrote I said that I expected the direct contribution of housing to be somewhere around a 1% drag on GDP growth for at least the next two quarters. October’s 14.6% drop in housing starts fits with that story, maybe pushing more weakness into 4Q06 than 1Q07. Of course, nobody was really expecting any miracles from the housing market at this point. More important is when will the housing downturn be felt more broadly outside of housing – when will the wealth effect begin to bite. I think it already is biting into the consumer, just not as violently as many had been expecting.
Which brings us back last week’s retail sales report. There was a bit of hand wringing over the retail sales report, which revealed a 0.2% drop from September. But these are nominal numbers, a realization that is often overlooked on the first pass of the data. Interpreting the report is especially challenging when you have large relative price changes, such as the plunge in gas prices we have seen in the past two months.
My sense was that, in real terms, the retail sales report was consistent with consumer growth of roughly 3% annualized in October. Sure enough, turning to the Wall Street Journal ($) the next morning:
While downward revisions showed that September retail sales were weaker than previously thought, sales excluding gas, autos and building materials rose 0.9% in the two months taken together. The numbers point to a rise in inflation-adjusted consumer spending in the current quarter of about 3% -- below the 10-year average of 3.7%, but still healthy. "That's a good start to the quarter," said Brian Jones, senior economist at Citigroup Inc. "You've got to think that we're going to have a pretty decent holiday shopping season."
The St. Louis Fed publishes a quick and dirty version of real retail sales, simply retail sales deflated by the CPI. Given the 0.5% drop in headline CPI in October, real retail sales were up 3.3% annualized in October. This probably understates the real gain – the weightings in the CPI are not equivalent to the mix of retail sales. Still, as an initial estimate of real personal consumption expenditures, it is not bad:
My take is that the retail sales report is consistent with my contention that real consumer spending is not falling off a cliff, but is easing back to a 2-3% y-o-y range. Interestingly, this might be an underestimate as well. The supposedly “weak” November reading on consumer confidence is signaling a solid consumer well into 4Q, with year over year real spending growth in the 3-4% range:
So where’s that housing effect? Truth be told, if spending comes in ahead of my estimates, it will be a little challenging to argue that housing is having much of an impact at all. To tease out the wealth effect, remember that given the relatively strong details of the October employment report, it would not be surprising to see that nominal wage and salary disbursements, which were up 7.6% y-o-y in September, posted another strong gain in October. Considering the inflation drop, the real equivalent would be even higher. On the surface, the household looks to have plenty of real spending power to push through the end of the year.
But maybe they have less than it seems. Switching back to nominal for the moment, the strong wage gains and flat retail sales suggest a rise in the savings rate. Notice the three month trend in the savings rate ending in September: -0.8, -0.5, and -0.2%. I wouldn’t be surprised to see the savings rate push into positive territory in October. But that doesn’t mean I think people are actually saving more in the commonly used sense of the term. I doubt that there has been a mass shift to higher 401k contributions for instance. We need to remember that part of the downward shift in the savings rate was driven by an artifact of the data. I make a capital gain on a housing sale. That gain is not counted as personal income, but when I buy a new car, the purchase is counted as consumption. Without that easy source of mortgage equity withdrawal (the result of a declining housing market), the associated spending dries up, and the savings rate rises in tandem.
In short, the acceleration of wage gains (now, with energy prices easing, both real and nominal gains) looks to be offsetting a portion of the housing impact, just as the housing impact offset weak wage gains in the wake of the recession. Of course, I could be wrong and households might have been caught by surprise by their spending power in October and now have some money burning a hole in their pocket (I doubt I am very wrong on the downside; we need to see some significant job losses to really pull the rug out from under the consumer. Those losses might still be in the pipeline, but don’t look to be showing up just yet). Not my baseline scenario, but maybe I am undershooting. From the Wall Street Journal ($):
Investors will also focus on consumer spending as the holiday season ramps up. A new survey by the International Council of Shopping Centers shows consumers may cooperate. On average, consumers plan to spend $676 on holiday purchases this year, up 9% from last year, according to the survey, helped by declining gasoline prices.
Given discounting, a 9% nominal gain would likely be a pretty solid real gain. There will, of course, still be considerable worry about the consumer throughout the holiday season, regardless of confidence or real retail sales figures that are unquestionably solid. After all, black moods about the consumer are the spirit of the season, partly because, in my opinion, retailers face a serious expectations problem.
Consumers know that their holiday spending is discretionary – there are very few must have items. Consumers know that if they hold out long enough, retailers will start slashing prices. And consumers know that if retailers managed to hold off the price slashing until after the holidays, the optimal strategy for consumers is to give a gift card, boosting the real purchasing power of the gift by pushing the actual purchase into the post-Christmas sales season. (As an aside, I believe that discounting by Wal-Mart is a false tell. It says less about the state of the consumer than of Wal-Mart’s market saturation.)
Bottom Line: The consumer looks weakened, but thanks to solid earning gains and declining inflation, not ready to give up the ghost. Mass job losses, however, would do more to put the nail in the coffin.