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Friday, June 08, 2007 4:03 PM

Sag in Consumer Spending

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The Wall Street Journal is reporting Spending May Sag as Debt Use Eases.

The latest data from the Federal Reserve show that American consumers are cutting back on borrowing and pulling less money out of their homes, moves that could signal a slowdown in spending.

The total amount the nation's consumers owe on credit cards, auto loans and other kinds of nonmortgage debt grew a smaller-than-expected $2.6 billion in April to $2.429 trillion, after jumping $14 billion ... the rest is subscription only
This sag is likely going to last longer than anyone thinks especially if rates keep rising. Anyone whose mortgage rate is going to reset this year and is not fully prepared for it is going to be in trouble.

The article went on to say that households are in good shape because of rising asset prices. I beg to differ.

Are Households in good shape?

Earlier today on Minyanville I asked these questions:

If consumers are in better shape why are defaults soaring?
If consumers are in better shape why are bankruptcies soaring?
If consumers are in better shape why is the negative savings rate getting much worse?

If Bill Gates walks into a bar the average wealth of everyone in the bar soars.
Did it help anyone?
If stocks rise does it help everyone uniformly or only those leveraged to stocks?

It is a huge mistake to only look at the asset side.
For those leveraged to equities, there is no guarantee stocks are going to keep rising.
What will that balance sheet look like if housing plunges further and stock take a 30% dive?
Is that all that unlikely?

GDP Forecast

I am not the only one who thinks the strength of this economy is going to be tested. Economist Paul Kasriel is writing: The More The Fed Delays Cutting The More We Cut Our GDP Forecast.
The Federal Open Market Committee (FOMC), the monetary policy arm of the Federal Reserve, has communicated that it is quite content to hold the federal funds rate at 5-1/4% for an extended period despite four consecutive quarters of sub-par real economic growth and a moderation in core consumer inflation (i.e., excluding food and energy components).

Why is the FOMC content to remain on hold? Because it has a forecast calling for enough of a rebound in economic growth later this year to avoid a recession and it desires further moderation in core inflation. We believe the FOMC will get its wish with regard to core inflation, but are less certain that its forecast of Gross Domestic Product (GDP) growth will pan out. One of the reasons we doubt the FOMC’s forecast will pan out without a little interest rate “self-help” is that it never has since 1960.

Since 1960, every time year-over-year real GDP gets around where it is now, 1.9%, the FOMC has engineered a federal funds interest rate cut. Sometimes these funds rate cuts have come in time to revive the economy. Other times the cuts have come too late to prevent a recession. This time, according to the FOMC and numerous economic forecasters, it will be different: we will experience an immaculate economic recovery. But we doubt it.

In our May economic update, we had assumed the FOMC would begin paring the federal funds rate in early August and finish at the end of October, for a cumulative cut of 75 basis points. As a result, we believed this would start to tilt the “nose” of the economy up by the fourth quarter of this year. Our real GDP growth forecast for 2007 on a Q4/Q4 basis in May was 1.9%. We now are lowering that forecast, in part because of the downward revision to first-quarter growth and in part because the FOMC is likely to delay cutting the federal funds rate. We do not see the first cut in the federal funds rate coming until October 31. Because of this delay in dropping the federal funds rate, we have lowered our second-half real GDP forecast to 1.7% vs. last month’s 2.25%. On a Q4/Q4 basis, our 2007 real GDP forecast is now 1.6%. Because of our lower real GDP forecast, we have now penciled in a cumulative decline in the federal funds rate of 100 basis points, with the last 25 basis points coming in mid-March 2008.

With regard to consumer spending, growth in the real spending for consumer durable goods slowed to 1.94% annualized in the three months ended April. This compares with growth of 12.36% in the three months ended January. Officials at U.S. auto makers have said the recession in the housing market is beginning to brake demand for their products. As Chart 2 shows, light motor vehicle sales have been stair-stepping downward since the beginning of the year. Durable goods related to housing, such as furniture and household equipment, also have seen the rate of growth in their purchases tail off (see Chart 3). Even growth in spending on clothing and shoes, which tends to be somewhat discretionary, has slowed sharply in the past three months (see Chart 4).
Overall Kasriel presents an interesting series of charts to support his view. But all in all I think he is a glowing optimist. (I think he will get a kick out of that. I doubt he has been called that before. Note to Kasriel: just teasing).

Housing Is Still The Key

The reason I say that Kasriel is an optimist is my belief that any delay in cutting rates is going to crucify housing as the interest rate refis start pouring in later this year and cash out refis supporting consumption continues to sink with an acceleration in the decline of home prices.

click on chart for a better look

It will be interesting to see how much the GDP rebounds because of inventory rebuilding (if at all), but after that it will be lights out. When it comes to rate cuts, I think the Fed is being disingenuous if in fact not telling blatant lies about their concerns over inflation. My belief is that they are totally spooked by the mania in leveraged buyouts, debt supported buybacks, and massive speculation in the markets. If they are not spooked by all those, they sure as hell should be.

As long as the mania continues their hands will be tied and they cannot cut rates no matter what happens to housing. The market has forced the Fed's hand.

Mike Shedlock / Mish

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