The Conference Board told us they were the most confident they have been in seven years, but the recent flavor of confidence is different than that of 2007. “Consumers” – meaning everyday Americans – saved more (5.6% versus 5.4%) than during the previous quarter. They also spent less: down 0.2% versus up 0.5% the previous quarter. But they also made more money: 0.7% more, according to the Employment Cost Index. And there is the rub. Consumers are bringing home more bacon and feeling good about it, but not enough so to open up their wallets to splurge on a new flat screen. This matters because consumer spending, including mortgage payments, accounts for roughly two-thirds of US gross domestic product, which bleeds through to influence interest rates. Real GDP grew solidly last quarter, at an annual rate of 3.5% according to the first of three such estimates, no thanks to the consumer. US GDP had to be bailed out by a surprise and “whopping” 16% increase in military spending. Overall government spending increased 10%, a nice improvement as compared to the self-imposed austerity (called “sequestration” in some circles) that created a nasty headwind the past couple years. The price of oil dropped, down to around $3 per gallon. You might expect fuel pump savings to increase the odds of said flat screen purchase, but a paper by economists at the Richmond Fed says not really. Lower gas prices might, however, explain the uptick in consumer savings. Either way, consumers are not pulling their weight, and we see it in the GDP data. Remember, second quarter GDP was 4.2% annualized, so even though the third quarter number looks good, it is still comparatively low.
None of this seems to matter for interest rates. Historically, higher GDP has meant higher interest rates as consumer confidence rises and spending increases. Consumers want to spend more money and so they are willing to pay more interest to borrow from a bank. But nowadays the ten-year US Treasury note, which helps determine rates such as those for thirty-year mortgages, is only 2.3ish%. Inflation is not pushing interest rates much, either. Last quarter’s Personal Consumption Expenditure reading, the Fed’s favorite inflation measure, came in at only 1.4% annualized, below expectations and the Fed’s arbitrary target of 2.0%. Consumers increased spending on services like healthcare, but durable goods purchases (cars and the like) declined. Without consumers picking up the slack, interest rates will have a tough time climbing very far, which is consistent with our current outlook. Right now, we do not see a powerful reason for consumers to change their minds and back up their alleged confidence with actual spending.
Sources: NYT, LA Times, Capital Economics, AAA, Richmond Fed, Conference Board, US Department of Commerce, Bureau of Economic Analysis, Bloomberg