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Consumers Won't Open Their Wallets Too Wide

Consumers Won't Open Their Wallets Too Wide

Americans aren't making much more money, but they still feel good. That's what the data say. Wages, salaries, and benefits grew at the slowest annual pace on record last quarter, but in July, consumer confidence bounced up after dipping in May and June.

The two trends speak volumes about the near-term outlook. The jump in confidence is another recent sign that consumers are ready to keep on spending (chart). But since earnings growth remains squeezed, households are not about to start spending so vigorously as to revive fears of overly rapid growth and inflation.

Despite last quarter's bumpiness, all this fits neatly into the soft-landing scenario. And such a combination of modest growth with low inflation may not preclude another cut in interest rates by the Federal Reserve.

Unfortunately, the bond market seems to think that better growth prospects scuttle chances for another rate cut. Bonds have slumped in recent ueeks, lifting the yield on the benchmark 30-year Treasury bond to nearly 7% on July 21. The rate has since retraced some of that rise to close near 6.9% on July 26.

The bond sell-off started with Fed Chairman Alan Greenspan's Humphrey-Hawkins testimony on July 19, when he suggested that the economy was more likely to pick up than to deteriorate. The slump accelerated when Fed Vice-Chairman Alan Blinder said the economy now looked better and that he was open-minded about the need for further easing. Blinder is thought to have been a major force in the July 6 rate cut.

BUT DESPITE THE ECONOMY'S firmer look, prospects for low or declining inflation appear to be the chief factor in the Fed's thinking right now. That was the reason it gave for the rate cut, and Greenspan hinted that falling price pressures would be a condition for further easing. The Fed's latest forecast actually projects lower inflation in 1996 than in 1995. That's a forecast the bond market should love.

Chances are good that the Fed's forecast will be right. That's because labor costs, the main force behind inflation, continue to grow at a slower pace. In the second quarter, the Labor Dept.'s employment cost index for all civilian workers--a measure of what businesses shell out for wages, salaries, and benefits--rose only 2.9% from a year ago. That was the same pace as in the first quarter and the lowest since Labor first started keeping records in 1982.

The growth of wages and salaries has actually stabilized. Straight pay is up 3% from a year ago, and it has grown between 2.8% and 3.1% annually during the past three years. Annual wage growth was equal to inflation last quarter after running slightly above it during the previous seven quarters. This measure of hourly pay shows some small gains in real purchasing power.

However, the biggest reason for the slower pace of compensation costs is the five-year slowdown in what businesses are paying out for benefits (chart). Such packages, about a fourth of total compensation costs, grew only 2.6% during the past year. That record low is down from 3.8% a year ago, and the pace has fallen steadily since reaching its recent peak of 7.4% in 1990.

Last quarter, as in recent quarters, less growth in benefits reflected a continuing slowdown in the cost to employers for health insurance, workers' compensation, and state unemployment insurance.

THE SLOWDOWN in compensation runs across all broad sectors. However, during the past year, workers fared better in service-producing industries than with goods producers (3.1% vs. 2.4%). White-collar occupations did a bit better than blue-collar (3% vs. 2.6%). And compensation for nonunion employees was up faster than that for union workers (2.9% vs. 2.3%).

Unions are having no luck hammering out better wage deals. Major collective-bargaining agreements settled in private industry in the second quarter lifted wages an average of 2.1% in the contract's first year and 2.2% annually over the life of the agreements. However, the wage settlements were, on average, lower than the agreements they replaced, and that has been the case now for 11 consecutive quarters.

While the slowdown in compensation bodes well for the inflation outlook, it is also a key reason why consumer spending in this expansion has grown slower than in any previous upturn--and why that trend should continue.

Consumers remained in fairly good spirits in July, however. The Conference Board's index of consumer confidence rose to 99.9 after slipping for two consecutive months. The rise recovered about half of that decline. The Board says the July reading is a "reassuringly strong level" and that households remain optimistic about the economy's health.

In particular, consumers' assessment of present conditions rose to a five-year high. And that's on the heels of what will probably be the weakest quarter of the year. Clearly, if the labor markets have deteriorated, that hasn't much affected consumers' attitudes.

WITH THAT IN MIND, one indicator to keep an eye on is initial jobless claims. They jumped sharply in each of the two most recently reported weeks, hitting 417,000 for the week of July 15. The four-week average of claims is now at the highest level since October, 1992 (chart). Claims for the week of July 8 were revised up by an unusually sharp 29,000, to 399,000, due mainly to a "significant keying error," says the Labor Dept.

Typo or not, the rise in jobless claims has not quashed consumers' hopes that the labor markets have improved. The Conference Board said more people in July felt jobs were plentiful than in June.

Greater optimism about job prospects may explain why the board's survey also found that more consumers planned to purchase homes and cars during the next six months. Indeed, sales of existing single-family homes rose 6.5% in June, to an annual rate of 3.78 million, following a 4.7% increase in May. That was the strongest two-month increase since 1983.

If consumers are confident enough to commit to a home purchase, they are usually looking to buy other goods as well. After solid gains in retail sales in May and June, July sales appear to be off to a good start. Sales at department and chain stores in the first three weeks of the month rose 1.2% from June, partly lifted by demand for hot-weather items, according to a survey of retailers by the Johnson Redbook Service.

Can consumers keep it up? Thus far this year, much of their buying has been done on credit. With installment debt rising toward record levels, especially when compared with disposable income, households will have to start trimming their use of plastic, and that cutback may sideline some shoppers.

Still, consumers base much of their spending decisions on their individual prospects for employment and income growth. And the latest data show that while pay raises aren't very exciting, consumers remain confident enough to keep spending into 1996.