Amid all of the recent economic data releases, the consumer spending figures stand out. The near-term outlook for the consumer has improved substantially, but financial market participants have yet to embrace the good news.
The UM Consumer Sentiment Index has risen sharply in the last few months, reflecting an improved job market outlook and the impact of lower gasoline prices. Consumers don’t spend confidence; income, wealth, and the ability to borrow are what drive spending. However, consumer attitude measures often provide a convenient assessment of the fundamentals.
Through the first eleven months of 2014, payroll gains were already the strongest of any full year since 1999. It’s no surprise then that job market perceptions are improving. Evaluations of current job market conditions are still far from normal, but they are moving in the right direction. Wage growth has remained subpar, but should pick up as the job market continues to tighten (probably more in the second half of 2015).
Lower gasoline prices are adding to consumer purchasing power. Putting less into their tanks, consumers will have more money to spending on other things. The drop in gasoline prices has been sharp, and at this point, seems likely to last.
The government recently raised its estimate of third quarter GDP growth to a 5.0% annual rate (vs. +3.9% in the 2nd estimate), with most of that revision coming from stronger consumer spending (a 3.2% annual rate, vs. +2.2% in the previous estimate). Moreover, monthly data reflect acceleration in 4Q14. The November figure on personal spending was higher than expected and spending growth was revised higher for each of the four previous months. Doing the math, inflation adjusted consumer spending (70% of GDP) appears to be tracking at a 4.0% to 4.5% annual rate in 4Q14. Of course, the personal spending figures are subject to revision. However, at face value, they paint a much brighter outlook for the consumer.
Note that the recent spending figures do not fully reflect the decline in gasoline prices, which should have a much bigger impact in the first half of 2015. A $1.50 drop in gasoline prices is equivalent to $150 billion in annual consumer expenditures. That’s about 0.9 percent of overall GDP. However, the impact will be a lot more than that, as the added spending boosts income. Businesses will also be saving on transportation costs. If sustained, the drop in gasoline prices should easily add more than a full percentage point to GDP growth (even accounting for the decline in energy exploration and production).
The stronger consumer spending outlook does not necessarily bring a Fed rate hike much closer. Labor market slack will be taken up at a somewhat faster pace, but there’s still plenty of slack remaining. Consumer price inflation was mild in 2014 (expected at 0.5%, December-to-December) – and some of the drop in gasoline prices is likely to flow through to core inflation, even if the Fed sees the impact as “transitory.”