Consumers Show a Willingness to Spend, but Can It Last?

Brent Schutte, CFA, is chief investment officer of the Northwestern Mutual Wealth Management Company.

Equities sold off last week, with the S&P 500 slipping into correction territory—down more than 10 percent from its July highs. Weak earnings results and growing concerns that the Federal Reserve will be forced to hold rates higher for longer to cool a seemingly still too-strong economy sparked the selling pressure.

While advance estimates from the Bureau of Economic Analysis (BEA) out last week show the U.S. economy grew faster than expected in the third quarter, details of the data cast doubt as to whether the growth is sustainable. The preliminary estimate showed that real gross domestic product (GDP) grew at a seasonally adjusted annual rate of 4.9 percent. The surge in growth was widespread, with increases seen in consumer spending, private domestic investment and Government expenditures. It’s important to note that the domestic investment went toward increasing inventories and contributes to 1.3 percent of the total growth number. Because spending on inventory is accounted for in the current quarter, it could show up as slower growth in future periods as it is used to meet future sales demand. Consumption came in at a 4 percent pace and contributed 2.7 percent to overall growth, with goods spending up nearly 4.8 percent and services up 3.6 percent, while gross private domestic investment rose 8.4 percent, and government was up 4.6 percent.

To be sure, preliminary estimates of GDP can be volatile and subject to meaningful revisions going forward; however, delving deeper into the report highlights a spurt of growth that may be short-lived. While consumption by consumers surged during the quarter, much of it appears to have been funded from savings, as real disposable income declined 0.25 percent and personal savings declined to $776 billion from $1.04 trillion in the second quarter. Accordingly, the personal savings rates declined to 3.8 percent from the previous quarter’s rate of 5.2 percent. The latest Personal Consumption Expenditures (PCE) report, also from the BEA, also showed that consumers were willing to open their wallets, with spending up 0.7 percent for the month despite personal income rising by a more subdued 0.3 percent. With recent studies by the Federal Reserve Bank suggesting that excess savings accumulated during COVID are likely exhausted and that the majority of consumers now have less cash on hand than before the pandemic, it is unlikely that consumers will be able to continue to prop up the economy unless wage gains remain at elevated levels.

As we’ve detailed in past commentaries, the Fed views wages as the remaining obstacle in its fight to bring inflation down to 2 percent. As such, we believe it will continue to let the 525 basis points in rate increase weigh on the economy until wage growth consistently slows to the low 3 percent range.

Given that businesses and consumers took advantage of historically low interest rates to borrow in the years leading up to the pandemic, we believe the full impact of the rate hikes has taken longer than widely anticipated to filter through the economy. However, we believe the cumulative effect of higher rates will eventually drag the economy into contraction. Fortunately, with current inflation measures still under control, we believe the Fed should be able to pivot quickly once it is satisfied that the threat posed by wage gains has been extinguished.

Wall Street wrap

Inflation holds steady: Last week’s PCE Index from the BEA showed that core PCE, which strips out volatile food and energy prices, rose just 0.3 percent in September, up from August’s 0.1 percent and the fastest monthly growth since April of this year. However, on a year-over-year basis, core PCE now stands at 3.7 percent, down from the prior month’s reading of 3.8 percent and at the lowest level since May 2021. The report showed headline inflation rose 0.4 percent in September, equal to August’s monthly rise, and is up 3.4 percent year over year, marking the third straight month at that level. The cost of services has been the driver of inflation during the past year, with a 4.7 percent year-over-year gain, while goods inflation is up just 0.9 percent during the past 12 months.

New home sales rise as prices fall: New home sales rose to a seasonally adjusted annual rate of 759,000 units in September, according to the latest data from the U.S. Census Bureau. The latest figure is up 12.3 percent from August’s revised total of 676,000, the fastest pace since February 2022. The jump in sales came as prices on new homes fell for a second consecutive month. The median price of a new home fell to $418,800, which represents a 3.3 percent decline from August and a 12.3 percent decline from year-ago levels. For further context, the current median sales price is 15.7 percent below the October 2022 high of $496,800. While new homes represent a small fraction of total home sales, the portion has grown of late as owners of existing properties have been hesitant to sell given that interest rates have risen and moving may result in higher interest payments on new mortgages. With interest rates at multi-decade highs, we would not be surprised to see further erosion in prices for new construction due to affordability issues caused by elevated rates.

Business activity improves: U.S. business activity showed a modest uptick in October. The latest preliminary data from the S&P Global Composite Purchasing Managers Index, which tracks both the manufacturing and service sectors, indicated that economic growth accelerated in October. The Composite Output Index reading rose to 51 (levels above 50 indicate growth), up from September’s final reading of 50.2. The latest reading marked the highest level since July of this year. While still technically in expansion territory, the latest measure suggests growth is modest.

The report showed the manufacturing side of the economy continues to tread water, with a headline reading of 50, up marginally from September’s final reading of 49.8. The current reading marks only the second time this year that manufacturing has posted a reading at or above 50; the prior occasion occurred in April, when the measure reached 50.2.

Services also came in with a slight improvement, with a reading of 50.9, up from September’s 50.1. The latest reading is the first increase going back to May of this year, when it was at 54.9. Demand in the services sector continues to ease, with the latest report showing a third straight month of declining new orders.

The subdued economic activity has made some inroads toward cooling hot labor demand. While results of the survey showed businesses continuing to hire, the latest report noted that “the rate of employment growth was only marginal overall, as many firms noted that voluntary leavers were not replaced due to uncertainty surrounding future demand conditions and efforts to make cost savings. Manufacturing firms even reported a fractional drop in staffing numbers on the month, despite the uptick in orders.” The decline in manufacturing payrolls marked the first decline for the survey since July 2020.

Capital spending holds steady: While much of the data out last week provided an updated picture of consumer spending, we also received some insights into business spending. Preliminary readings for September show business fixed investment moved higher, with non-defense capital goods orders excluding aircraft rising 0.6 percent in September, down from August’s upwardly revised reading. Shipments were flat after August’s 0.8 percent increase. On a year-over-year basis, readings are up modestly, with capital goods orders excluding defense and aircraft rising just 0.8 percent and shipments up 1.4 percent over the past 12 months.

Jobless claims increase: Weekly jobless claims numbered 210,000, up 10,000 from last week’s upwardly revised figure. The four-week rolling average of new jobless claims came in at 207,500, an increase of 1,250 from the previous week’s revised average. Continuing claims (those people remaining on unemployment benefits) were at 1.79 million, an increase of 63,000 from the previous week and up from the low of 1.658 million in early September. Although the most recent data shows that layoffs remain relatively low, the upward trend in continuing claims may point to displaced workers facing greater challenges in finding new jobs.

The week ahead

Tuesday: The Conference Board’s Consumer Confidence report will come out in the morning. Given the Federal Reserve’s ongoing focus on the employment picture, we will continue to focus on the labor market differential, which is based on the difference between the number of respondents who believe jobs are easy to find and those who report challenges finding work.

We’ll be watching the S&P CoreLogic Case-Shiller Index of property values. Home sales and prices overall have continued to sag over the past few months, with some regions showing stability while others see prices continue to fall. We will be watching to see if the latest uptick in mortgage rates has put pressure on prices.

Wednesday: The focus for the day will be on the Federal Reserve as it releases its statement following its monthly meeting. We expect the Fed will hold rates steady, and we will be listening for indications of whether the Fed believes wage growth remains too strong for the Fed to achieve its target of 2 percent annual inflation.

The Bureau of Labor Statistics (BLS) will release its Job Openings and Labor Turnover Survey report. We’ll watch for whether the gap between job openings and job seekers is continuing to narrow, which would help ease wage pressure for businesses.  

The manufacturing sector will be in focus as the Institute of Supply Management (ISM) releases its latest Purchasing Managers Manufacturing Index. Recent readings have shown the sector in contraction territory, and we will monitor for any signs of change in direction. This report, along with Friday’s ISM report on services, will provide a clearer view of the economy in total.

Thursday: Initial and continuing jobless claims will be announced before the market opens. Initial filings were up last week as were continuing claims, and we will continue to monitor this report for sustained signs of changes in the strength of the employment picture.

Friday: The BLS will release the Jobs report. We’ll be watching to see if the slowing pace of job and wage gains continued in August. Importantly, we will be monitoring the labor force participation rate to see if the recent rise in new entrants joining the workforce is continuing. A rise in labor force participation could help ease the current elevated wage pressures.

The ISM releases its latest Purchasing Managers Services Index. Recent readings have shown growth in the sector slowing, and we will watch for any signs of additional weakening.

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