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One of the green shoots of recovery is starting to look a bit brown—and it's a big one. Consumer spending in April fell for the second month in a row, dropping below its first-quarter average and pointing to a tough road ahead for both households and the economy. At best, outlays adjusted for inflation have only stabilized following their dizzying plunge in the second half of last year, brought on by $4 gas and a near financial meltdown. At worst, consumer frugality is a growing risk to the broadly expected shift toward renewed economic growth in the second half.
The depressing effects of shrinking payrolls, lost wealth, and tight credit remain intense. Real, or inflation-adjusted, consumer spending posted a modest 1.5% annual rate of increase in the first quarter, but all that growth occurred in January. Monthly data since then show no momentum. In fact, spending in May and June will have to post at least moderate gains to prevent a dip back into negative territory. But weekly chain store reports through May look soft, and the pickup in the month's car sales largely reflected temporary discounting to clear out inventories.
Now, two new headwinds are blowing against prospects for third-quarter spending. First, sharply higher yields on Treasury notes are lifting mortgage rates. The average 30-year fixed rate rose to more than 5.25% at the end of May, after holding at about 4.8% earlier this year. The rise threatens to dampen home demand and kill off the refinancing boom that is bolstering the health of some households. Plus, the price of oil is pushing toward $70 per barrel. Gas prices are already up more than 60 cents per gallon since Mar. 16, to $2.52 on June 1. That rise will cut into buying power and negate some of Washington's stimulus.
So far, none of that stimulus has helped spending, although the Making Work Pay tax credit was fully implemented into withholding schedules in April. A $64 billion drop in taxes paid helped fuel a $122 billion surge in aftertax income in April, but households saved all of the gain. The savings rate jumped to 5.7%, a 14-year high, and the pressure to save is increasing. Since the last recession, consumers' liabilities have grown almost twice as fast as aftertax income. Huge wealth gains had helped consumers live with that imbalance, but since the middle of 2007, household net worth has plunged by more than $13 trillion.
Despite massive job losses, aftertax income has grown at a solid 8.3% annual rate so far this year. That pace reflects lower taxes and help from other income-support programs, including a big 5.8% cost-of-living boost in January for Social Security recipients, who also will get a $250 one-time payout in May. Wages and salaries, which make up three-fifths of aftertax income, have declined 3.6% annually this year, but all other income has grown 29%. Still, spending has barely grown, as households have either salted away their gains or used them to pay down debt.
The problem for the second half is that the size of government income support is set to diminish. That will put more pressure on wages and salaries to fill the gap, even as job losses remain large and as higher gas prices further erode buying power. If pump prices rise much further, real aftertax income in the third quarter will fall sharply, which would weigh heavily on spending, especially given consumers' desire to save more of what they make.
The jump in consumer confidence in April and May offers hope that increased faith in the future will lead to a pickup in spending. For now, though, the record two-month gain in the Conference Board's index from an all-time low most likely reflects relief that the economy has avoided a depression. The gauge remains historically low, and unemployment is expected to approach 10% in coming months.
All this is not to imply more recession lies ahead. Recent positive signs from the stock market, manufacturers, and emerging-market economies suggest a turnaround is near. However, consumers don't appear ready to contribute to a recovery anytime soon.
Cooper is BusinessWeek's senior editor and senior economist and writes the influential Business Outlook column.