Shoppers Don't Look Ready To Put Away Their Wallets

Once again, consumers are under the microscope. If they spend on a modest but rising trend, the economy will keep chugging along, the Federal Reserve won't have to cut interest rates, and the Clinton Administration can breathe a little easier as the 1996 election year rolls around.

But what if households decide to pack it in? After all, the consumer sector is the economy's 900-pound gorilla whose purchases account for two-thirds of U.S. economic activity. That's why the recent downbeat consumer-related data have economy-watchers from Wall Street to Washington pacing the floor out of worry over a possible recession.

For example, the 0.2% rise in May retail sales was weaker than expected. Jobless claims are trending higher, underscoring the soft labor markets. And the modest pace of consumer inflation indicates businesses are facing lackluster demand and excess inventories, and so cannot raise prices much.

However, the current weakness in the consumer sector is far from alarming, and longer-term fundamentals argue that consumers are unlikely to cut spending drastically and send the economy spiraling downward. Balance sheets appear extremely healthy, helped by rising stock and bond prices and steady home values. Households show little problems in paying their bills, and consumers still have a high level of confidence.

THE MAY RETAIL REPORT was a disappointment for those hoping for a clear sign that consumers are on the rebound. The news, so close on the heels of the June 2 report of 101,000 fewer jobs in May, further heightens the policy pressures on and within the Fed.

May's puny rise did not recoup the 0.3% sales drop in April. Car sales rose 0.5%, but building materials purchases--a victim of the housing slowdown--plunged 1.7%. Sales at gasoline stations fell 0.7%. For the first two months of the second quarter, real retail sales were down at an annual rate of 1.9%, compared with their first-quarter average (chart).

Smelling an imminent rate cut, the bond market rallied fiercely after the June 13 release of the retail data. The yield on 30-year Treasury bonds closed at 6.54%, down from 6.7% the day before, the strongest one-day rally in nearly a year.

That reaction seems a bit hysterical. Despite weak outlays for goods, the data so far suggest that real consumer spending will rise by 1% to 1.5% in the second quarter--mainly because service outlays began the quarter strongly. Even if inventory growth slows substantially, that pace is not consistent with the zero-to-negative expectations for second-quarter economic growth now increasingly popping up.

A LOOK AT HOUSEHOLD FINANCES shows why consumers are not ready to throw in the towel. The Federal Reserve reports net financial assets acquired by households continued to rise in the first quarter, at an annual rate of $556.6 billion.

Consumers may not be quick to use their investments as a source of cash during this slowdown, however. One reason is that many investments, such as 401(k) plans and IRAs, cannot be touched. Also, baby boomers are in their saving years, so they may not be willing to cash in their equity windfall. And investors may wait to see if Congress cuts the capital-gains tax, reducing the cost of selling stocks and bonds.

Still, the sense of increasing wealth may be a reason why consumer confidence has stayed fairly high, even amid signs of a softer economy.

Looking at the liability side of their balance sheets, consumers are in much better shape than they were prior to the 1990-91 recession. Consumers have added debt at an explosive rate over the past year. Installment credit alone grew by $11 billion in April.

But the Fed also reports that households needed only 16.1% of their disposable income to make their debt repayments at the end of 1994, and economists at Regional Financial Associates Inc. estimate that percentage has risen to only 16.4% in the second quarter. Both rates are way below the peak 18.4% hit in 1989. In addition, mortgage delinquency rates fell to a 22-year low in the first quarter, and only 1.5% of other debt payments were late.

Healthy finances argue that consumers will head back to the malls. In fact, it may already be happening. The Johnson Redbook Report says that sales at discount and chain stores for the first two weeks in June were up 1.6% above their May average. Plus, the Conference Board's May survey of buying plans found that more consumers planned to buy cars and major appliances than at any time in the past year.

A return of shoppers will ease the current production disruption caused by the need to adjust inventories. As of April, that process had not yet begun. Stock levels at manufacturers, retailers, and wholesalers jumped 0.8% in the month, as sales fell by 0.4%. That was the second month in a row that inventories rose strongly amid falling sales (chart, page 31).

By May, though, businesses appeared to be whipping their inventories into better shape, especially the auto industry. The nation's purchasing managers said that inventory growth slowed sharply in May, and car dealers ended the month with a 69-day supply of cars and trucks. That's down from April's huge 78-day supply and closer to the desirable 60-day total, although further output cuts will be needed.

PARING DOWN excess inventories will continue to brighten the already radiant inflation news. Consumer prices edged up 0.3% in May, and excluding food and energy, core prices rose 0.2%--half of the April advance. Smaller increases in the prices of cars, airline tickets, and auto financing led the moderation.

Over the past year, consumer prices have risen 3.2%, and core prices are up 3.1% (chart). Although both rates are slightly above their 1994 performances, the speedup is within the range that the Fed will tolerate.

Inflation for goods and services has been modest. Service prices have risen 3.5% in the year ended in May, and goods prices are up only 2.6%. Goods inflation may come under downward pressure in coming months as retailers cut prices to move merchandise.

Already, the disinflationary effects of slower business activity are evident among producer prices. Producer prices of finished goods were unchanged in May, while core producer prices edged up 0.3%. Both inflation measures are rising by about 2% from a year ago.

Further back in the production process, price pressures showed signs of easing in May. Core prices of intermediate materials and supplies rose just 0.2% in May, after a 0.7% jump in April. And core prices of crude materials fell 0.3%, after a 1.2% gain in April.

Later this year, as consumers pick up their pace and inventories grow less burdensome, factories will hum again. That rebound will be crucial for keeping the economy on an even keel--and preventing investors and policymakers from too many anxiety attacks.

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