Markets & Finance

The Economy: An Upbeat End to July


A raft of data releases on July 31 shows that consumers remain optimistic and factory sentiment is solid, though labor-cost gains could trouble the Fed

The end of July brought a barrage of U.S. economic reports providing a wide range of interesting insights on income and consumption, key factors in the economy's continuing growth even amid the ongoing housing slump. The rest of the day's releases included reports of firmness in labor costs, lean construction spending, respectable factory sentiment, and a surprisingly robust consumer confidence level.

Overall, the positive and negative surprises offset one another, leaving the economy on track for a solid gross domestic product performance in the third quarter, following a second-quarter gain that we consider to be in line with the advance gross-domestic-product figure of 3.4%. The still-solid growth and the nettlesome inflation figures scuttle prospects for a Federal Reserve rate cut any time soon. They will give the central bank sufficient cover to continue its hawkish inflation stance at next week's Federal Open Market Committee meeting, despite hopes by some that volatile markets will prompt the Fed to soften its tone.

Here is Action Economics' rundown of the July 31 releases:

Personal Income: Personal income rose 0.4% and spending edged up 0.1% in June. May's 0.4% increase in income was not revised, though the 0.5% increase in spending was revised to up to 0.6%. The core personal-consumption-expenditure (PCE) deflator, an inflation gauge, was up 0.1% on the month, for a 1.9% year-over-year pace. That's down from a revised 2.0% rate posted in May (1.9% previously).

The report revealed income and spending gains that were largely in line with the June employment and retail sales reports, along with big upward income revisions and lower consumption trajectory over the last three years evident in the advance second-quarter GDP report.

The June figures are consistent with the reported 1.3% real (adjusted for inflation) consumption growth clip in the second quarter, and an estimated 2.8% rate in the third quarter, as the surge in energy prices that depressed real spending in the second quarter is being partly reversed in the third quarter.

Employment Cost Index: The ECI, a gauge of labor market inflation, rose 0.9% in the second quarter after a 0.8% increase in the first quarter. Wages and salaries were up 0.8% after a 1.1% increase in the first quarter. Benefit costs were up 1.3% after a tame 0.1% first-quarter rise.

On a year-over-year basis, the ECI slipped to a 3.3% pace from 3.5% previously. Wages and salaries are up 3.4% after a 3.6% rate in the first quarter. Benefit costs rose to a 3.4% clip, however, from 3.1% previously.

The 0.8% wage gain in the ECI report leaned to the strong side, given the hefty 1.1% surge in the first quarter that left a solid two-quarter combo. The gains modestly outpaced the hourly earnings gains in the monthly employment reports, which showed 0.9% gains in each quarter.

The 1.1% second-quarter benefit cost surge was more significant, as it reversed the good news in the first-quarter figures and reinforced the likelihood that we are seeing the end of the three-year downward correction in benefit cost growth.

The report signals ongoing risk of strong unit labor cost increases. For the second quarter we do expect a fairly restrained 1.4% gain, which follows the similarly lean 1.8% rate of the first quarter. But the two quarters follow a jumbo 8.9% rate in the fourth quarter of last year, when big bonus payments were booked, and this mix will boost the year-over-year figures through the second and third quarters of this year.

Construction Spending: Construction spending fell 0.3% in June after a revised 1.1% surge in May (from 0.9% previously). Spending was down 2.4% year over year. Nonresidential spending rose 0.1% in June after a 2.5% surge previously. Residential spending continued to slide, falling 0.7% in June after a 0.5% decline in May.

The residential construction figures revealed downward revisions that will negatively affect the residential figures in the next monthly round of estimates for second-quarter real GDP growth, leaving a rate of decline closer to 12% than the 9.2% reported rate. But the nonresidential construction figures in the June report were stronger than expected and should leave a bump toward 27% in the 22.2% growth rate reported for this measure in the advance GDP report.

The revisions in total were a wash for total GDP growth in the second quarter, and they remain consistent with third-quarter forecasts of a 14% rate of decline for residential construction and a 13% growth clip for nonresidential construction.

Chicago Purchasing Managers' Index: The Chicago PMI, a regional manufacturing survey, fell to 53.4 in July, following the index's surge to the heady level of 61.7 in May and June's index reading of 60.2. The subcomponents were mixed, however. The employment index rose to 61.6 from 52.7. The new orders index fell to 53.4 from 65.7. Prices paid climbed to 73.1 from 68.1. The component data, in total, were consistent with the solid round of data seen in the Philly Fed and Empire State regional reports, and suggest a healthy reading for the Institute for Supply Management's index for the month as well.

Consumer Confidence: The Conference Board's U.S. consumer confidence index surged to 112.6 in July from a revised 105.3 in June (103.9 previously). That was much better than expected and reflects a very resilient consumer. The present situations component rose to 139.2 from 129.9 (revised from 127.9). Expectations were 94.8 from 88.8 in June (revised from 87.9). The inflation data moderated, with the one-year expectation median at 5.1%, vs. 5.4% in June.

Generally, the various confidence measures moderated through the second quarter from surprisingly high first-quarter levels as soaring gasoline prices and interest rates took their toll. Yet, the confidence figures have held surprisingly firm as we enter the third quarter, with a new cyclical high set for today's measure for July. This is consistent with a bounce in retail sales in July following the notable June underperformance and expectations of solid consumption and GDP figures for the current quarter.

Englund is chief economist for Action Economics.

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