Trading Places: Consumers Disappoint, Businesses Rebound

Personal disposable income dropped 0.3% in October after adjusting for inflation. The weakness largely reflects the end to farm subsidies, which provided an artificial boost to incomes over the summer. The government added payments for striking workers at GM but there was likely some drag from the collateral damage of the strike, especially in the hardest-hit communities.

Personal consumption expenditures edged up a tepid 0.1% in October after adjusting for inflation. That is less than half the pace we saw over the summer, which marked a slowdown from the second quarter. A drop in spending on big-ticket durable goods, including vehicles and furniture, was partially offset by a surge in heating bills. October was unusually cold across much of the country. Add a flurry of bad storms the week of Thanksgiving and retailers are getting nervous. They built inventories ahead of the September 1 tariffs to blunt the effect of the tariffs on holiday spending. Now, they have to unload those inventories in a shortened holiday season while the weather is keeping people from the stores; there are only 26 days between Thanksgiving and Christmas this year. Discounts will remain deep this holiday season.

The personal consumption expenditures (PCE) index of inflation edged up 0.2% in October, largely on the heels of higher energy prices. However, the year-over-year measure of the index slowed to a 1.3% pace in October. The core (excluding food and energy) PCE index rose a more modest 0.1% during the month and slipped to a 1.6% pace from a year ago. That is well below the Federal Reserve’s 2% target for the index. So far, rate cuts have failed to produce the heat in wages and prices the Fed wants to see.

Moreover, recent confidence surveys suggest that the labor market deteriorated a bit this month. The rebound from the GM strike should obscure that weakness when the official November employment data for the month is released on December 6. The Fed will be watching for a stronger rebound with the December employment data due out in early January.

Businesses Fare Better

Conversely, businesses surprised to the upside in October with durable goods rising instead of falling during the month. A pickup in aircraft orders more than offset a drop in strike-related losses in the vehicle sector. Core orders were even stronger which, when coupled with core shipments, suggests we could get a small bounce in business investment in the third quarter. The outlier is the steel industry, which is still contracting, as tariffs and weakness abroad have taken a toll on demand.

The primary concern is inventories, which were revised up for the third quarter and continued to grow in October. In fact, the upward revision to inventories accounted for nearly all of the upward revisions to real GDP growth over the summer. The economy is now estimated to have growth 2.1% instead of the 1.9% initially reported.

The overhang of inventories will have to be drained during the last two months of the year and as we move into early 2020. This could derail what little positive news we saw for business investment in October.

Bottom Line

Consumers are showing signs of weakness even as businesses are finally showing signs of life. Growth in the fourth quarter is now expected to slow to a 1.6% pace, one-half percent weaker than we saw in the third quarter. This, combined with the ongoing deceleration in inflation, could pull the Fed back into the game of cutting rates sooner than it had hoped in 2020.