Further evidence has emerged pertaining to the rising concerns we have (and risk to our base case) regarding the health of the US economy as 2006 progresses.
High inflation or slow growth: putting the brakes on consumer spending
May’s data revealed real consumer spending improving by just 0.1%, taking the annualised three month rolling rate down to just 1.7%, a halving of the levels recorded just six months ago.
It would probably be too depressing to readers to reproduce the chart showing the parlous state of US savings again. However, take it from us that there would have been no monthly improvement in spending were it not for a further deterioration in the savings ratio!
How long will investors have to wait before the full impact of higher energy prices (a negative $100bn on consumption due to relatively inelastic demand, this year), higher interest rates and stagnating house price growth begin to weigh seriously on consumer spending? The latter contributes more than 66% of national GDP.
In order to satisfy the “must have it now” urge against a back drop of incomes which are barely improving at all on an inflation-adjusted basis and in which the housing sector appears increasingly parlous, consumers are becoming even more wedded to debt.
Drilling even deeper into the income picture reveals that, stripping out energy-related inflation and taxes, real disposable income growth was 0.0% in May, 0.0% on a rolling quarter by quarter basis and just 1.4% year on year.
Looking at corporate profit growth goes nothing like far enough towards telling the whole story. With labour income close to negative territory in real terms it is hardly surprising that we view the inflation picture as very much less of a problem than some elsewhere in the market might.
High inflation or slow growth: remember the deflation threat?
Back in 2002/03 the writer bought heavily into the threat posed by all-out deflation exported to the West by the rapidly developing Asian economies. As it happened the Federal Reserve just managed to fight its way back into control, clambering back into the driver’s seat and hauling the wheel round before the truck careened over the precipice. Admittedly, at 1.0% nominal there was precious little left in the barrel had the real economy failed to respond to the treatment.
As we all know, it’s not what one knows but what one does not know that counts for everything in the financial markets. According to some work by Merrill Lynch there were some 3,098 recorded mentions of the word “deflation” in the US press alone by June 2003.
Back then, as we know by looking carefully at Fed missives from the time, Mr Greenspan himself was deeply exercised by the possible threat of all-out deflation and its consequences. To a large extent concerns about inflation now and deflation then have their roots in the same place, the Federal Reserve. The word “inflation” appeared 1,293 times in US print media in May and 1,082 times in June.
High inflation or slow growth: why you should watch the Fed
In retrospect the deflation threat, so alive in 2003, never materialised (like a dangerous comet which we might be warned about but which seems to dodge our planet at the last moment). The Fed cut core base rates, the bond yield curve steepened aggressively and activity levels surged. It is more than likely that the reverse may be happening now. The Fed is overly aggressive against a backdrop provided by a flat to marginally inverted yield curve and an economy which even by the Fed’s own admission is beginning to run out of momentum!
The time to start buying US Treasuries (5-10 year range according to veteran contrarian investor Ned Davis in Barron’s magazine) must now be very close at hand. How some can fear inflation when the “pass through” in the real economy is as weak as it is, real income growth is under pressure, growth seems set to slow and spare capacity is likely to rise markedly is beyond our comprehension!
By Jeremy Batstone, Director of Private Client Research at Charles Stanley