Personal disposable income growth has been slowing, a trend that threatens to derail the economic recovery–if it rolls on. Deciding if this hazard has reached the point of no return is still an open debate, which is why Friday’s update on income and spending for February will be closely analyzed for clues about the next phase for the business cycle.

The consensus forecast sees modest growth for the monthly change, but what’s needed is something considerably stronger to stabilize if not reverse the two-year deceleration in the annual rate. One reason for thinking optimistically is related to wage growth, which has growing at a considerably higher rate vs. disposable personal income (DPI). Wages represent roughly half of personal income and so the two will eventually converge. But convergence in recent history is in short supply, as the chart below shows. Since last summer, the two have been moving in opposite directions on a year-over-year basis, with DPI (red line) falling while the pace of wage growth (blue line) has turned higher.

Rising wages alone may not be enough to keep the economy out of a new recession, but it’s a safe bet that keeping growth alive is a whole lot tougher if wage growth slows sharply in the months ahead. In the last update, wages were rising by 5% a year, according to the Bureau of Economic Analysis. Growth is good, but 5% isn’t all that impressive in historical terms. The more immediate worry is that wage growth will tumble. That would be ominous, since it would strengthen the warning in DPI’s slowdown.
This much is clear: the gap between the annual rates of changes for wages and income overall will close… eventually. The details of how and when it closes remain the stuff of speculation. As for dissecting the clues in hand, Karl Smith at Modeled Behavior reports that “the biggest drag on personal income right now is the decline in transfer payment from the government.” He continues:

At first this seems natural as the economy is recovering and automatic stabilizers like unemployment insurance work in both directions. They slow the descent into recession but as they roll off they also slow the recovery.

Yet, the recent numbers were to big to explained by unemployment insurance alone. It turns out government health care spending is dropping by unprecedented amounts.

What does this mean for next round of personal income and spending data? We’ll know more on Friday. But whatever’s coming, the front line in the battle to keep the economy expanding is still closely linked to job growth. On that note, tomorrow brings us a new number for the weekly initial jobless claims report. Last week’s update showed a fresh drop to a new four-year low, which implies that the labor market will continue to expand. Will that be enough to counteract the perception of trouble ahead if Friday’s income and spending report disappoints? And the answer is….