Personal Incomes Outpace Spending

After-tax incomes rose 0.3% in September after rising an upwardly revised 0.5% in August. Farm subsidies paid out over the summer were major contributors to overall income growth. The subsidies the government is paying farmers exceed the bailouts that were provided to vehicle producers during the worst of the Great Recession. The blow from tariffs has hit small farms hardest.

Consumer spending came in a bit shy of expectations, rising only 0.2% in September. Revisions to August were also to the upside. Gains were driven by a pickup in spending on vehicles and health care. Consumers have grown more cautious in their outlays for discretionary purchases including restaurants and accommodations in recent months. Concerns about a full-blown trade war triggered that caution over the summer and appear to have persisted as we moved into September despite efforts to de-escalate by both the administration and China. The caution showed up as consumers traded down to cheaper restaurants and hotels instead of cancelling vacations all together.

The personal saving rate jumped to 8.3% in September. That marks the highest level since March and suggests that consumers will be entering the holiday season with ample cushion to keep spending even if business investment weakens further. Holiday spending is expected to pick up fairly significantly over last year. The threshold on 2018 holiday sales is low because consumers pulled back during the height of the holiday season in December when fears of a trade war intensified, triggering a stock market sell-off.

The personal consumption expenditures (PCE) inflation index flatlined during the month of September and slowed to a 1.3% on a year-over-year basis. Prices at the gas pump helped put a cap on inflation for the month. Core PCE, which strips out the volatile food and energy components, also moved sideways in September. That brought the core PCE down to a 1.7% pace on a year-over-year basis in September. This is still tracking below the Federal Reserve's 2% target and one of the many reasons that the Fed decided to cut rates a third time this year in October.

Separately, the employment cost index, which measures both wages and benefits compensation increased at a 0.7% pace in the third quarter. Overall wage gains held at a 2.9% from a year ago, the same as we saw in the second quarter. That marks a deceleration from late last year, when wage gains topped 3%. Benefits have also lost some steam since late last year, the opposite one would expect with unemployment so low. Many firms have said that they are offering less costly benefits, such as casual dress and more flexible work schedules to lure employees. Amazon plans to use more robots this holiday season to deal with labor shortages.

Bottom Line
The consumer remains in good shape as we enter the holiday season but not as euphoric as one would expect so late in the economic cycle. That underlying anxiety will show up as continued restraint on eating out and staying in hotels. Higher air fares triggered by the loss of routes with the 737 Max grounding are additional hurdles for the service sector this holiday season.

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