With Europe and China as weak as they are, the U.S. manufacturing sector is unlikely to be able to maintain its strong upswing much longer. For his part, the U.S. consumer has been dipping into his savings since mid-2010, enabling him to satisfy some pent up demand and grow consumption by more than 4% YoY throughout the last 2 years in spite of dwindling growth in his disposable income.
The U.S. consumer has often in the past grown his expenditures faster than his income but never for a sustained period. It has now been 10 months during which his savings rate has dropped from 5.0% to 3.7%, contributing $150B or 34% to the $436B in increased spending during the last 12 months.
The savings rate is now at its lowest level since 2008. It reached lower levels during the peak of the housing bubble but it is doubtful that Americans will let reckless debt buildup happen again for another one or two generations. It surely would be very adventurous to expect the savings rate to average much less than 3.5% over the next year at least, along what was observed between 2000 and 2005.
Keeping the admittedly volatile savings rate constant, PDI will evolve along with the changes in employment, wages and tax rates.
U.S. employment growth has accelerated to 245k per month since December 2011. It had averaged 89k per month since 1990 but the yearly average reached 200k only once (2005) since 2000. During its best period of 1993 to 1999, monthly employment gains averaged 251k.
However, it is important to note that up until 2008, government employment was almost invariably positive, averaging 20k per month between 1990 and 2008. Only in recent years have we seen substantial job losses at the various government levels, a trend likely to continue for a while.
Private employment growth has not exceeded 200k per month since 1999 and even during the boom internet years of 1993-99, private employment averaged 232k per month. Its recent 250k monthly average of the last 3 months is therefore unlikely to be sustained, even more so in the current economic environment. It is much more reasonable to expect private employment growth averaging 150k per month during the next 12 month period which, coupled with an average 5k monthly loss for government jobs would result in total employment growth averaging 145k per month from now on in 2012.
If that proves right, employment growth will cruise at a rate of 1.5% YoY for the rest of 2012. The upside if employment growth averages 200k is 2.0% YoY.
Wage gains, as measured by average hourly earnings, have been steady at 0.1% MoM for 7 months now. The YoY growth rate was 1.9% in February but if the recent monthly trend holds, the YoY growth rate will gradually decline towards 1.2% by year-end.
If we assume wage gains in the 1.5% range, employment income should thus grow in the 3% range with upside to 3.5%. This would be a significant slowdown from the 5% YoY growth rate of the last 5 months. But the slowdown is already occurring as wages and salaries have only increased 1.0% in total since October, exactly at a 3% annual rate.
There is no more help coming from government transfers. Quite the opposite, personal taxes are on the upswing as more people work and more states raise tax rates. The average personal tax rate has slowly climbed back from its 2010 lows. It was 11.1% in February, up from 10.8% last September when employment started to pick up. Needless to say, tax rates will likely act as a break to PDI growth from now on, even more so after the elections…
In all, nominal PDI growth slumped to 2.6% YoY in February, a little noticed but nevertheless significant slowdown from the 3.7% average growth rate of the previous 12 months. The U.S. economy was spared by the huge drop in the savings rate, a phenomenon unlikely to continue. Since PDI growth is likely to be contained within 2.5% and 3.0% during the rest of the year, spending growth can only slowdown even more from its 4.6% pace of the last 12 months.
The PCE price index was +2.3% YoY in February, down from a recent peak of +2.9% last September. Nonetheless, real PDI rose a meager 0.3% YoY in February compared with a still low 0.7% average monthly gain since July 2011.
While nominal PDI growth is slowing, the PCE deflator is accelerating: it rose 0.3% MoM in February and is up 0.6% (+2.4% a.r.) in the last 3 months, primarily due to rising energy prices. With nominal PDI growth limited to 2.5-3.0%, it goes without saying that if inflation stays in the 2.5% range, real income growth will simply stall.
The impact of rising oil prices, mitigated in recent months by the very warm winter, will become more damaging on discretionary income as 2012 progresses unless oil prices decline as much as they did last spring and summer. Gas prices averaged $3.65/g between June and September 2011 before plunging to $3.25 by year-end, just in time to free some discretionary income for Christmas. Can we be as lucky this year?
Can another SPR release provide enough relief? In June/July 2011, the IEA released 30mmb of oil to offset the loss of Libyan production during the Arab Spring. Oil prices initially declined some 5% but recouped it all within a week as markets worried about actual spare capacity. It took the Eurozone crisis to bring oil prices down meaningfully in August and September.
Looking further out, the U.S. fiscal cliff is approaching pretty rapidly and, unless Congress again kicks the (heavier) can further out, a slew of measures will shortly hit the economy (expiration of the Bush tax cuts, ending of the payroll tax cut, declining unemployment benefits and “automatic” $1.5T budget cuts).
The U.S. fiscal cliff is such that it should be seriously taken care of early in the first year of the next presidential mandate with the inevitable fiscal drag hitting the economy. However, the significant ideological divisions between Democrats and Republicans and the likelihood that neither party will secure 60 votes in the Senate mean that the gridlock will likely need to be broken, painfully for everybody including financial markets, by the bond vigilantes. Consumers and businesspeople will no doubt remain cautious as a result.
Martin Feldstein summarized the threat in a recent op-ed in the FT:
But the most important cloud on the horizon is the large tax increase that will occur next year unless there is legislation to block it. (…) That increase of $512bn is equivalent to 2.9 per cent of GDP, bringing federal revenue as a share of GDP from 15.8 per cent this year to 18.7 per cent next year.(…)
The risk of dramatic tax increases and an economic downturn next year affects the behaviour of businesses and households today. Companies that expect large tax increases in 2013 and potentially another downturn in the near future will be reluctant to invest or hire this year. And individuals who think their personal taxes may rise next year will also cut back on current spending on “big-ticket” and other discretionary items.
The U.S. consumer is in no position to continue to support the U.S. economy. In fact, it will soon stop supporting the world economy, given what Europe is going through and how China is weakening.