U.S.: Consumers: Still Some Pluses among the Minuses

Job markets are stabilizing, and mortgage refis are fattening wallets

For almost two years now, consumers have done all the heavy lifting in this economy. Their steadfast spending, which accounts for two-thirds of gross domestic product, made the recession one of the shallowest on record, and growing demand by households almost single-handedly jump-started the recovery. The question now: With businesses still generally gun-shy about the future, can consumers continue to lead the economy into 2003?

The outlook for consumer spending is still a mixed bag, but the pluses continue to dominate the minuses. To be sure, September wasn't a good month for consumer buying, a sign that fourth-quarter spending is unlikely to match the strong third-quarter advance of about 4%. But don't sell households short just yet. After all, month-to-month buying trends have been erratic all year, especially given the on-again, off-again "free-money" deals that caused big ups and downs in car sales.

More important, the news about the September labor markets wasn't as bad as widely feared (chart). Despite a dip in September payrolls, revised August employment gains were three times larger than first reported. Hours worked are rising, and weekly pay continues to outpace inflation. Plus, as mortgage rates fall further, refinancing is setting records. Extra money from cashouts and lower monthly payments will give consumers some extra buying power in the fourth quarter.

THAT'S GOOD, BECAUSE the economy may need some help this quarter. The stock market plunge is weighing heavily on both businesses and consumers, and confidence remains fragile, especially as the U.S. appears to be getting closer to invading Iraq, with unknown consequences for oil prices and geopolitics.

Consumer spending numbers will also take a hit from an expected swing in vehicle sales. Thanks to zero-percent financing, light trucks and cars sold at an annual rate of 17.8 million in the third quarter. The rate this quarter is expected to fall by about 1 million. Fewer car sales are a big reason spending won't be as strong this quarter as it was in the third, and neither will be the rise in overall gross domestic product.

At least the fourth-quarter outlook got one unexpected piece of good news on Oct. 8, when President George W. Bush ordered an 80-day "cooling off" period for the West Coast dock shutdown. Bush's use of the Taft-Hartley Act means that the economy might recover some of the lost activity caused by the 10-day port closure. Even so, the shutdown might skew some of the October data, especially foreign trade and jobless claims, and the backlog of imports and exports will take weeks to clear out.

The effects of the dock shutdown are only temporary, however. Consumer spending, and thus the economy, depends more lastingly on job prospects. So the best news for the outlook is that the labor markets, although still weak, have at least stabilized. Despite the decline of 43,000 in September payrolls, jobs have grown ever so slightly for two quarters in a row, after huge losses in the previous year. Even with the September dip, payroll increases have averaged 35,000 per month since April. Manufacturing, which shed another 35,000 workers in September, continues to bear the brunt of the job losses. Excluding factory payrolls, monthly job gains have averaged 66,000 since April.

MOREOVER, PAY GAINS for those workers on the job are holding up fairly well (chart). Hourly earnings of production workers posted good increases in both August and September. Although the yearly growth in pay slowed this year, hourly earnings are still rising 3%. With inflation well below that pace, the buying power of workers is growing.

Plus, hours worked in September rose for the second consecutive month, recovering all of the July drop and allaying fears of a double-dip recession. The sharp decline in July hours might have been a knee-jerk reaction by businesses to the summer's stock market slide. But after that, the workweek rose by 6 minutes in August and 12 minutes in September, to 34.3 hours. That rebound is important, because a longer workweek often precedes hiring.

With gains in both hourly pay and hours worked, weekly pay in September jumped by 0.9%, the largest monthly increase in five years. That puts pay on a solid footing heading into the fourth quarter. Measured from the year before, weekly pay in September grew at a healthy 3.7% clip.

CLEARLY, JOB GAINS remain far too slim to keep the unemployment rate down, so labor jitters won't completely disappear. The September drop in joblessness, to 5.6%, might have eased some of those concerns, but the decline, from 5.9% in July, will almost certainly be reversed in coming months. Typically, payrolls have to grow by more than 150,000 per month to reduce the unemployment rate. Given the high rate of productivity, hiring is unlikely to get that strong anytime soon.

The drop in the jobless rate points up the dichotomy between the two surveys that go into the Labor Dept.'s employment report. The household survey, from which the unemployment data are derived, is separate from the survey of businesses that produces the payroll data. The September phone survey of households shows that employment rose 1.1 million from July to September. That's the fastest two-month gain in 12 years, surpassing the hiring boom of the late 1990s. In the survey's defense, it often picks up new hiring strength at turning points in the business cycle before the payroll survey, but results of this magnitude look especially odd in light of other trends in the economy.

Because of strong productivity growth, the economy's 3% pace over the past year should be about sufficient to keep the unemployment rate from rising much above 6%. However, with more output coming from productivity gains than from new jobs, the rate could remain uncomfortably high for some time.

It isn't just the labor market that provides optimism about the consumer sector. Homeowners are getting a financial boost from the record wave of refinancings. In early October, loan applications to refinance an existing mortgage soared to a record that was 25% above the previous high set in 2001 (chart). Low rates are also enabling consumers to use home-equity loans in place of other debt. Installment credit has slowed from its pace of 2000 and 2001. That has allowed debt outstanding as a percentage of disposable income to slip from a high of 22.5% in late 2001.

In the end, though, the labor market will be the main driver of consumer confidence and spending habits. The September job report indicates the worst is over. And while consumer spending won't be gangbusters this quarter, it will be a plus for real GDP growth.

By James C. Cooper & Kathleen Madigan

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