Consumer Spending's Tireless Dynamo

Neither higher home-mortgage rates nor the job market's weakness is likely to see wallets snapped shut and the recovery scuttled

By Amey Stone

Investors are consummate worriers, and despite some upbeat economic news lately, many are still fretting about rising interest rates and the persistently weak labor market. American consumers are a bolder crowd, however. Even after three years of a desultory economy, there's little reason to doubt their Herculean strength.

True, the mortgage-refinancing boom may be over for now, a victim of the interest-rate spike. As of mid-August, the number of applications to refinance home loans was down more than 70% from its May peak. Yet even if refinancing is no longer putting cash in consumers' pockets, plenty of other forces continue to do so.


  For starters, the Bush Administration's tax breaks have arrived in full force, helping to propel retail sales (not including autos) to a healthy 6% gain in July over the same month last year. Wal-Mart's (WMT ) sales rose 12% in July, vs. the same month in 2002. August measures of chain-store sales also have jumped. And the stock market is helping to put consumers in the mood to spend. It's up 13% so far this year, including a 300-point jump from early August.

Best of all for encouraging spending, says Milton Ezrati, senior economist and strategist at Lord Abbett & Co., wages are on the rise. He expects incomes to increase at a 3.5% to 4% annual rate for the rest of this year -- and for consumer spending to keep pace. Says Ezrati: "I don't see any reason consumers will pull in their horns."

Even this year's most worrisome trends really aren't that troubling on closer inspection. For example, despite the 30-year mortgage rate's jump from 5.21% in June to the current 6.35%, rates remain near historic lows, according to's Aug. 20 survey. That may have put the brakes on refinancing, but it shouldn't stop people buying homes. In July, housing starts hit a 17-year high. Adjustable-rate mortgages, while not always advisable, are still very low (one-year ARMs average 4.14% according to, making home-buying affordable for many people, points out Edward Deak, an economics professor at Fairfield University in Connecticut.


  A recent dip in consumer confidence had some economists wringing their hands. But that was likely due to the temporary lull in the stock-market rally that lasted from mid-June through the first week in August, says Ezrati. Even so, consumer-confidence measures remain far higher than they were in 2001.

Consumer demand could also get a further infusion. If Iraq steps up its crude oil output, lower fuel prices could be a major stimulus to consumer spending. In an Aug. 12 report, Prudential Financial economist Edward Yardeni calculated that a $5-a-barrel drop in oil prices would mean the equivalent of a "$150 billion tax cut for global consumers of oil."

Most important to consumer-spending growth is a rebound in the labor market. Even though investors were disappointed by a second-quarter decline in payrolls, hope for an upturn remains. The Labor Dept.'s weekly report on first-time claims for unemployment benefits, released on Aug. 21, showed an unexpected improvement. Claims came in at 386,000 -- and anything below the 400,000 mark usually signals an expansion in hiring.


  "Low rates on one hand and tax cuts and rebate checks on the other will help prolong consumer spending," says Deak. "If businesses respond by hiring more workers, we'll be in great shape." John Lonski, chief economist at Moody's Investors Service, is betting that large gains in payrolls will materialize by yearend. "Companies are slowly but surely being forced to increase staff," he says. The recent rise in interest rates, he points out, was triggered by renewed vigor in the underlying economy.

Even if the labor market doesn't improve or slackens further, there's a safety valve that should keep consumer spending going, says Lonski: If growth starts to falter, rates will fall again, pushing mortgage rates low enough to trigger another refinancing boom. Notes Lonski: "That would provide an offset."

A jump in rates large enough to derail the still-robust housing market is the biggest threat to consumer spending and the overall economy. But Lonski thinks mortgage rates would need to rise to around 8% for buyers to disappear and home prices to dip -- an unlikely scenario, given the Fed's current policy of keeping rates low.


  For now, there are a lot more reasons to bet on a far more optimistic scenario -- that the economy will improve while 10-year Treasuries, which some economists believe are now too high, will fall a bit from their current level of 4.5%.

Conclusive proof that vigorous economic growth will continue isn't in yet, and it's possible that the second-quarter jump in business spending was an anomaly (see BW Online, 8/14/03, "Behind the Surge of Capital Spending".) But investors have no reason to fear that shoppers will flee the malls. The weight of the economy may be a heavy load for consumers to shoulder, but they've been doing it for three years now. And unlike their timid counterparts in Corporate America, they remain determined to spend, spend, spend.

Stone is an associate editor of BusinessWeek Online and covers the markets as a Street Wise columnist and mutual funds in her Mutual Funds Maven column

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