August 1, 2017
Consumer Spending – I’ll Bet that Q3
Real GDP Growth Will Be Closer to Q1’s than Q2’s
It’s too hot to go sailing today, so I thought I’d
“unpack”, as the kids on cable news say, second quarter real GDP and real
personal consumption growth (PCE). I will argue that the quarter-to-quarter
acceleration in the growth of both second quarter real GDP and real PCE was due
more to arithmetic than a fundamental acceleration in the growth of aggregate
demand. To refresh your memory, real GDP annualized growth in the second
quarter was 2.6% versus 1.2% in the
first quarter. Real PCE growth annualized growth in the second quarter was 2.8%
versus 1.9% in the first quarter.
Let’s take a look at the month-to-month annualized real
PCE growth over the first six months of 2017 (see Chart 1). The median
month-to-month annualized real PCE
growth during this time period was a paltry 0.6%. The outlier during this
period was March, when annualized real PCE growth was a whopping 9.2%. The
annualized growth rate of real PCE in April, May and June were 0.20%, 2.20% and
0.45%, respectively. The three-month average of the annualized growth rates of
real PCE for April, May and June was 1.15%, a far cry from the 2.8% annualized
growth in the quarterly average level
of real PCE.
Chart 1
It was the surge in real PCE growth at the end of the first quarter that boosted
second-quarter real PCE growth. Plotted in Chart 2 are the monthly levels of seasonally-adjusted at annual
rates of real PCE along with their three-month averages for the first six
months of 2017. Let’s concentrate on the data points for March and June. The three-month
averages of the PCE levels for March and June also are the first and second quarterly averages, respectively, of the
levels of real PCE. If you do the arithmetic you will find the March level of
real PCE was 0.49% higher than the average level of real PCE for the three
months ended March or the first-quarter average level of real PCE. If the level
of real PCE had simply remained at its March level in April, May and June, the
second-quarter average level of real PCE would have been equal to that of the
March level. In this case, annualized growth in second-quarter real PCE would
have been 1.97% (1.0049 raised to the fourth power and so on and so forth). Because the March level of real PCE was so
far above the first-quarter average, this biased upward the second-quarter
average level of real PCE and thus, second-quarter annualized growth in real
PCE. But what March giveth, June taketh away. The June level of real PCE
was only 0.085% above the average level of real PCE for the three months ended
June, or the second-quarter average. If the level of real PCE were to remain at
the June level in July, August and September, then annualized growth in real PCE in the third quarter would be only 0.3%! So, while second-quarter
annualized growth in real PCE started the quarter with a strong tailwind,
third-quarter growth is starting with hardly any wind at its back. In order for
annualized growth in third-quarter real PCE to match the second quarter’s 2.8%
growth, the month-to-month annualized changes in real PCE would have to be
about 1.2%, double that of the median month-to-month
annualized percentage changes in the second quarter.
Chart 2
Real PCE contributed 1.9 percentage points to the second
quarter’s 2.6% annualized growth in real GDP. If growth in real PCE slows in
the third quarter, which quarterly-averaging arithmetic suggests it will, then
growth in third-quarter real GDP is likely to slow, too. But there also is a
fundamental reason why third-quarter real PCE growth is likely to slow – you
guessed it, sluggish growth in thin-air credit. Plotted in Chart 3 are monthly
observations of the behavior of the sum of bank credit and the monetary base.
The bars are the year-over-year percent changes in monthly thin-air credit. The
line traces the month-to-month annualized percent changes in thin-air credit. In
June, the year-over-year percent change in thin-air credit was 2.6%, the
slowest growth in 12 months. In June, thin-air credit contracted at an annualized rate of 0.4% versus May. Sluggish growth in thin-air credit is not the stuff of robust growth in
consumer spending.
Chart 3
If the Fed does, in fact, begin paring its outright
holdings of securities in September, then it had better start engaging in
repurchase agreements. Otherwise the monetary base will shrink and, all else
the same, there will be upward pressure on the federal funds rate. If the
monetary base shrinks, thin-air credit growth will slow further unless there is
an offsetting increase in bank credit. If thin-air credit growth slows further
in the months ahead, investment-grade bond yields will fall more from their
already-low levels – barring a Treasury default emanating from a failure to
raise the federal government debt ceiling.
Lastly, my former Northern Trust colleague, Asha
Bangalore, has announced her retirement. Her last day at Northern will be
August 14. Asha joined me at Northern in 1994. Any success I might have had at
Northern was, in large part, due to having Asha as a colleague. She was my “Radar”
O’Reilly, knowing what we needed and obtaining it long before I even thought of
it. I was always in awe of Asha’s time-management skills. Where as I am a
congenital procrastinator, Asha immediately tackles any project regardless of
how difficult or boring it might be. I was blessed to have had such a
knowledgeable and capable colleague as Asha. Asha, best wishes as you enter
this new phase of your life. Who knows, perhaps we can put the team together
again if you get bored in retirement?
Paul L. Kasriel
Founder, Econtrarian,
LLC
Senior Economic and Investment Advisor
1-920-818-0236
“For most of human
history, it made good adaptive sense to be fearful and emphasize the negative;
any mistake could be fatal”, Joost Swarte
