Oil prices continue reaching into record-high territory, but the consumer, so far, isn’t blinking. The sight of sharply rising energy costs and continued trips to Wal-Mart has surprised more than a few dismal scientists, and caused a few ripples here and there in terms of expectations for corporate earnings. But by and large, given the magnitude of oil’s rise, the American economy has remained largely unaffected by any notable degree. Can this strange dance of ascending consumer spending and energy prices continue? Perhaps, but not without ramifications.
Stephen Roach, Morgan Stanley’s chief economist, predicts that something’s got to give if Joe Sixpack keeps spending and energy prices remain high. The way Roach figures it, Joe will either cut back on everything from vacations to buying DVDs, or else his continued his financial profligacy will sink the U.S. national savings rate below its current level of zero.
As choices go, Roach’s bifurcated forecast of the economic future is more than a little disturbing—if you believe it. Clearly, some don’t. The strategists at Griffin, Kubrik, Stephens & Thompson, for instance, earlier this week dismissed the threat of an energy bull market as a consumer killer. “For at least the past three years, there has been a constant drumbeat of pessimism surrounding rising energy prices,” a GKST report published Monday observes. “Yet, retail sales have accelerated consistently. Retail sales, excluding gas station sales, rose just 2.8% in 2002, but were up 3.9% in 2003, 6.5% in 2004, and are up 7.6% during the year ended in Q2 2005.” Oil prices, of course, have ascended into the heavens over that span. Crude averaged $26.10 a barrel in 2002, GKST reports. Yesterday, a barrel closed over $67 for the first time.
If the past is prologue, the optimism of the GKST folks is reassuring. On that note, this morning’s update on weekly initial jobless claims delivered another reason to think the economy continues to chug along handsomely, thank you very much. For the week ending August 20, initial filings for unemployment slipped 4,000 to 315,000 from the previous week, the Labor Department reports. Save for a few times this year, weekly jobless claims haven’t been this low since 2000.
As for Joe’s willingness to spend, a fresh measure of his urge to spend comes next week, September 1, when personal income and spending for July is released. Meanwhile, there’s the Roach advisory to consider, or dismiss: “If the American consumer fails to adjust in the face of an energy shock, U.S. national savings will plunge further — taking an already massive current account deficit to the flash point,” he writes. “This would have profound implications for a US-centric world that is utterly lacking in support from autonomous domestic consumption.”
Such fears would quickly fade if and when oil prices pull back from recent highs, Roach continues. “Unfortunately, that’s a bet the financial market consensus has been making for far too long.”
The advance warnings to monitor on this front in terms of market sentiment include the dollar and gold. But like so many other metrics, these two gauges offer a mixed message. The dollar is again looking weary, giving aid and comfort once again to Roach’s worst fears. Indeed, the U.S. Dollar Index’s rally this year seems to have topped out last month. Gold, on the other hand, has been in a holding pattern for much of this year, although the metal’s been inching higher over the past few weeks. Nonetheless, if the precious metal carries a warning, it’s less than compelling at the moment.
For bond investors, the incentive to buy the 10-year Treasury continues to fade as competing rates of shorter maturities move higher. A five-year certificate of deposit averages 4.11%, according to Bankrate.com, just a hair below the current yield on the 10-year Note. Meanwhile, the two-year Treasury yields 4.00%.
Why buy a 10-year Treasury at 4.16% when something comparable can be had in debt instruments of shorter maturities? Stephen Roach may have an answer. Indeed, if the consumer gives way, sending the economy into a tailspin, the 10-year’s prospective capital gains could yet prove alluring. But if Joe Sixpack keeps spending himself into financial oblivion, the current account deficit may fall deeper into the red, perhaps triggering a sell off in the dollar and sending interest rates sharply higher.
The Federal Reserve might be pleased with the latter scenario. The central bank, after all, is desperately trying to convince bond traders to sell Treasuries so as to raise long-term rates. To date, no luck, although the Fed presumably will keep trying. The next FOMC meeting comes on September 20, and there are still a fair number of strategists expecting yet another 25-basis-point hike in Fed funds.
All in all, the theme of something’s got to give seems like a fair assessment of the financial and economic scene of the moment. Exactly what gives and when, of course, remains the unknown, but a rising tide of pundits think energy will be a key variable one way or the other.
David Kotok, chief investment officer of Cumberland Advisors, echoes the Roach advisory. In an email to clients today, Kotok reviews history and notes that the personal savings rate was higher from the 1970s through the early 1990s relative to today’s goose egg. In fact, the savings rate was around 9.5% in the 1970s, and peaked at 11.2% n 1982, vs. zero currently, he comments. Although the savings rate declined in the 1990s, it was still safely positive. “Those higher savings rates acted as a cushion to absorb the higher energy costs…” he advises. “In this energy cycle, the cushion is gone.”
Perhaps the bull market in housing will step in and fill the gap this time around, although Kotok’s skeptical of this savior if in fact there’s a real estate bubble in the works and it’s poised to pop.
The crunch time will come this winter, Kotok predicts, when the heating season is in full swing. “Many households will be squeezed and have to cut back on their spending. We think this will show up soon in lower estimates for the growth rate of the U.S. economy,” he writes.
Perhaps the first sign that the Kotok outlook will come to pass if and when the Fed blinks first by ending its campaign to raise rates. The bond market, bless its one-track-minded soul, continues to bet on no less.