Consumer Spending Remains Sluggish

MBA (6/2/2008 ) Velz, Orawin
The economy grew at an annualized pace of 0.9 percent in the first quarter—slightly stronger than initially reported—following a 0.6 percent increase in the previous quarter. Trade was the biggest boost to growth, while domestic demand—gross domestic product (GDP) excluding net exports and inventory changes—declined for the first time since the fourth quarter of 1991.
The upward revisions also changed the mix of the components of GDP, improving the outlook for second quarter growth. In addition, a separate report of a strong increase in April durable goods orders, excluding transportation equipment, also bodes well for future business investment. In the face of declining domestic demand, manufacturers have benefited from overseas demand, boosted by global economic growth and the declining dollar.

Domestic demand continued to be weak going into the second quarter. Personal consumption expenditures (PCE), which account for more than 70 percent of GDP, rose 0.2 percent in April but remained unchanged after adjusting for inflation. Over the past year, real spending has increased 1.6 percent, its slowest pace in about six years. Real spending growth has been anemic over the past five months. In particular, consumers have cut back on their spending on big-ticket items. Real spending on durable goods has increased only once in the last seven months.

The tax rebate checks, which have been distributed since April 28 and will continue through July, should help lift spending growth in the coming months, at least temporarily. The extent of the boost to spending is uncertain, given rising energy prices as well as consumers’ concern about their personal finances and the outlook of the economy. Measures of consumer confidence continued to slide in May. For example, The Conference Board Consumer Confidence Index has reached its lowest reading since October 1992. Its expectations for the next six months component—believed to be more closely related to consumer spending than the current conditions component—slumped to the lowest reading on record. The University of Michigan Consumer Sentiment Index has shown sharper declines, reaching the lowest level since June 1980.

While core inflation (excluding food and energy items) was benign in April, with the PCE deflator edging up only 0.1 percent, the rising trend in food and energy prices has led consumers to expect higher inflation. Consumer expectations of inflation over the next year from The Conference Board’s survey soared to 7.7 percent, the highest level on record back to 1987. According to the University of Michigan survey, one-year inflation expectations jumped to 5.2 percent, their highest level since 1982.

Finally, new home sales showed a sign of life in April, showing the first increase since October 2007. A quick turnaround for the housing market is not expected, however, as data in previous months were revised lower, and the months’ supply of nearly eleven months is still extraordinarily high.

Treasuries dropped and yields rose through Thursday in response to stronger-than-expected economic data and investors’ inflation concern. The yield on 10-year Treasury notes rose to 4.08 percent by Thursday, the highest level since late December. The 10-year yield fell on Friday on news of tame core PCE inflation, hovering around 4.04 percent by mid Friday afternoon. The Fed is widely expected to keep the fed funds rate at 2 percent at the next meeting on June 24-25.

Housing and Mortgage Indicators:
New homes sales were up 3.4 percent in April to a seasonally-adjusted annualized pace of 526,000. However, the increase followed the downward revision of the previous months’ figures. April’s sales pace was the same as the sales pace initially reported for March, and the drop in March new home sales were revised down to 11.0 percent from a previously reported of 5.3 percent.

Sales of new homes during the first four months of this year were down 36.7 percent from the same period last year. Sales have declined about 62 percent since their peak in July 2005. Sales increased in three regions: 41.7 percent in the Northeast; 5.8 percent in the Midwest; and 8.3 percent in the West. Sales dropped 2.4 percent in the South.

The number of homes available for sale fell 2.4 percent to 456,000, the 12th consecutive monthly decline and the lowest level since June 2005. The steady decline in inventory reflected considerable cutbacks in single-family homebuilding.

A drop in inventory and an increase in sales pace pushed the months’ supply down to 10.6 months in April from 11.1 months in March (previously reported as 9.8 months). Despite the decline, the months’ supply stood at the fourth highest reading since the inception of the series in 1963.

Another indicator of sluggish housing demand was the sharp increase in the length of time houses have spent on the market. The median number of months rose to 8.0 months in April, the highest level since record keeping began in August 1988. The median number of months on the market averaged 5.7 months in 2007.

The median price for new homes rose 1.5 percent in April from a year ago, the first year-over-year increase in the past five months. The increase followed a sharp drop of 14.1 percent in the previous month. The reason for the increase in home prices may be due to a change in the mix of sales: the only region where sales declined last month was in the South, where a typical home costs much less than in the Northeast and the West, both of which saw big increases in sales in April.

The S&P/Case-Shiller quarterly national composite index was down 14.1 percent in the first quarter from a year ago, following an 8.9 percent year-over-year decline in the fourth quarter of 2007. The drop was the biggest since the series began in 1987. It has now fallen about 16 percent from its peak in the second quarter of 2006. The S&P/Case-Shiller Home Price Indices track repeat sales of the same single-family house over time. They are therefore a better indicator of home price trend than average or median home prices, which can be distorted by the mix of sales of low- and high-priced homes.

Economic Indicators:
The Conference Board Consumer Confidence Index fell 5.6 points to 57.2 in May, the fifth consecutive drop. Both the present conditions component and expectations component fell. The measure of expectations for the next six months slumped to 45.7, the lowest reading on record. Rising energy prices, volatile stock markets, falling house prices and credit market concerns likely weighed on confidence.

Consumers’ assessment of current labor market conditions deteriorated modestly. The share of consumers finding jobs plentiful fell to 16.3 percent, the lowest level since April 2004. The share finding jobs hard to get rose to 28.0 percent, the highest since November 2004.

Plans to buy homes dropped to their lowest levels since October 1982; plans to buy autos also dropped sharply; but plans to buy appliances held steady.

Durable goods orders declined 0.5 percent in April following a 0.3 percent drop in March. Transportation equipment orders fell 7.9 percent, led by a 20.0 percent drop in aircraft orders. Motor vehicle orders, which account for more than half of transportation orders, fell 3.3 percent.

Excluding the volatile orders for transportation equipment, orders were up 2.5 percent, the biggest increase since July 2007. Increases in new orders for electrical equipment, appliances and components and machinery were largely responsible for the increase in overall orders. Orders for electrical equipment jumped a record 27.8 percent, more than offsetting an 18.9 percent drop in March.

Shipments for nondefense capital goods excluding aircraft—a component used in the calculation of economic growth in the current quarter—rose 0.5 percent. Nondefense capital goods orders excluding aircraft—a proxy for future business investment in equipment and software—jumped 4.2 percent, the first increase this year. The strong increase bodes well for third quarter economic growth.

The preliminary estimate of first quarter gross domestic product (GDP) showed that economic growth was slightly stronger than initially reported. Real (inflation-adjusted) GDP grew 0.9 percent in the first quarter of this year, an upward revision from 0.6 percent reported in the advance estimate. (Unless otherwise noted, data reported here are seasonally-adjusted annualized rates.)

The overall upward revision to growth was the result of several factors. Downward revision to imports, upward revision to investment in nonresidential structures and upward revision to consumer spending on nondurable goods all increased GDP. These impacts outweighed downward revisions to inventory investment, exports, consumer spending on services and government spending, all of which reduced GDP.

The housing market was the biggest drag to growth, subtracting 1.2 percentage points from real GDP growth. Real residential investment declined 25.5 percent in the first quarter, improving from a previously estimated 26.7 percent drop, but still the biggest quarterly drop since the fourth quarter of 1981. Housing has been a drag on growth for nine consecutive quarters, the longest downturn since the series began in 1947.

The trade sector has been a positive influence on economic growth over the past year. It was the biggest boost to growth in the first quarter, adding 0.8 percentage points, significantly more than the 0.2 percentage points previously reported.

Inventories declined in the first quarter instead of the increase reported in the advance estimate. While the downward revision reduced GDP, it was nonetheless positive for the current quarter economic growth. An unintended increase in inventories bodes ill for future economic growth as businesses will likely pare down production to reduce unwanted stockpiles. The drop in inventories in the first quarter suggested that businesses will have to increase production if demand picks up in the current quarter.

The report also included a first look at corporate profits for the quarter. Earnings adjusted for the value of inventories and the depreciation of capital expenditures (or profits from current production) increased 0.3 percent to an annual rate of $1.57 trillion. Most of the gain came from overseas, where it was helped by global economic growth and the weak dollar. Domestic profits increased only modestly, with higher profits from nonfinancial businesses slightly outweighing losses in financial services.

Personal income rose 0.2 percent in April after a 0.4 percent increase in March. The end of bonus payment season weakened personal income growth, while tax rebates inflated disposable income growth.

Personal consumption expenditures (PCE) also increased 0.2 percent, decelerating from a 0.4 percent gain in March. Spending on services increased, spending on durable goods declined, and spending on nondurable goods was flat.

Real spending and real disposable income were unchanged in April. Overall inflation, as measured by the PCE deflator, rose 0.2 percent. Excluding food and energy items, core prices were up 0.1 percent in April and 2.1 percent from a year ago.

The University of Michigan Consumer Sentiment Index fell to 59.8 in May from 62.6 in April. Current conditions fell 3.7 points, while expectations fell 2.2 points.