Consumers jumped on discounts and credit to leverage their incomes in November, with spending slightly outpacing solid, inflation-adjusted, disposable income gains during the month. Spending on big-ticket vehicles and holiday gifts both bounced back after an October lull. Discounting played a large role in supporting spending on everything from vehicles to clothing. Prices at the gas pump also continued to decline, which allows consumers to feel more comfortable about their ability to service debt, with or without major increases in wages. We are viewing the drop in energy prices through this prism as it will provide a tailwind for credit usage and spending as we move into 2016. What consumers once thought was a one-off in lower gas prices, they are now putting into their expectations for the future.
In fact, overall inflation as measured by the more accurate personal consumption expenditures (PCE) index remained unchanged for the month and moved up less than many at the Federal Reserve had hoped to see, compared to a year ago. Overall inflation rose a still tepid 0.4% from a year ago, while the core PCE (our best indicator of future inflation) remained at a stubborn 1.3% pace from a year ago. Services did not deliver; they were expected to get a boost while other categories lagged in response to the strong dollar and falling oil prices. That is all despite the surge in rents we continue to see and a pickup in spending on health care. Something to watch next year is how a jump in health care premiums and deductibles affects health care spending. Adverse selection for coverage under the Affordable Care Act had boosted spending and inflation in that category in 2015; it now could slow fairly abruptly, especially if wages don’t come back rapidly. Surveys of renters from Zillow suggest that rising rents hit health care spending the hardest.
Separately, durable goods orders disappointed by flatlining in November after being revised down in what had been an unusual show of strength in October. More importantly, core orders, which strip away the volatile aircraft and unreliable defense components of the index, actually fell in November. Machinery and the oil and mining sector were hit hardest, suggesting that anything we gain in consumer spending from the fall in oil prices will continue to be dampened by cuts in investment in the oil and gas industry. Shipments were a bit better as inventories continued to be drawn down. The question is whether we can count on businesses outside of the oil sector to invest next year. It is looking dicier than I would like to see, so close to the end of the year.
Bottom Line: The Federal Open Market Committee (FOMC) bet on consumers carrying us through the ongoing headwinds from abroad; so far, they are doing so. Persistently tepid inflation was raised as a concern even as the Fed attempted liftoff. That concern appears warranted. The outlook for accelerating wages and inflation in 2016 is still more of an expectation than a reality. This is one of many reasons the Fed is expected to move even slower to raise rates than some FOMC members would like in 2016.
