We’re now two-thirds of the way through 2Q13. However, the second quarter economic picture is still sketchy. We have some data for April, which is subject to revision. Figures for May will begin arriving this week. Despite the cloudy near-term economic picture, the financial markets are looking ahead to better growth in the second half of the year.
Personal income was reported as flat in April. Recall that the April Employment Report showed relatively good growth in nonfarm payrolls (+165,000), but the positive impact was offset by a drop in hours (to 34.4, from 34.6). As a result, aggregate wage and salary income was essentially unchanged. Taxes fell during the recession and increased gradually over the last few years as the economy recovered. Tax rates have risen this year, restraining disposable income. In April, personal taxes were up 11.4% from a year ago, while payroll taxes were up 17.0%.
One would expect the increase in taxes to put a damper on consumer spending growth. Consumer spending rose at a 1.7% annual rate over the second half of 2012, but rose at a 3.4% in 1Q13. Some of that may reflect the uncertainty of the fiscal cliff, but it seemed like an odd result given the increase in taxes. There is evidence that many individuals were unaware that the payroll tax rate rose in January. Some individuals maintained consumption levels by reducing contributions to savings and retirement accounts or by borrowing. Inflation-adjusted spending slowed in April, which suggests that we may be seeing a lagged impact of the payroll tax increase. At the upper end of the income scale, gains in stock market and housing wealth have been supportive. Anecdotal information suggests that spending growth is uneven across income levels.
Manufacturing figures for April were mixed, with general weakness in production, but some pickup in orders. Production of construction materials and autos is likely to remain positive in the near term. However, export growth has softened over the last several months, reflecting weak global demand.
One of the major concerns for investors is when the Fed will begin tapering the rate of asset purchases. The Fed wants to see “substantial improvement” in labor market conditions, but we’re not there yet. It’s widely expected that the Fed will start tapering after the September monetary policy meeting, but that will clearly depend on the economic data.
Long-term interest rates have risen recently, but the outlook for QE3 is only a small part of the story. Recall that it is the total amount of Fed purchases that matters, not the pace. Bond yields are not rising because of inflation fears. Inflation has been trending lower (which ought to give the Fed some leeway to delay the tapering of asset purchases). Bond yields appear to have risen largely on the outlook for better economic growth in the second half of the year. Still, that outlook is very uncertain. We should get a clearer picture as the economic data roll in. Perceptions could change relatively quickly.
© Raymond James