The financial markets have been ailing for more than a year but the economic troubles are only just beginning, as today’s batch of sobering updates reminds.
Perhaps the most damning evidence is the news that personal consumption expenditures (PCE) dropped by 1% last month: the biggest monthly fall since September 2001. The difference now is that the economic context is fundamentally and deeply negative whereas the tragic events of 9/11 were temporary and largely unrelated to the otherwise recovering trend. No such luck this time. We had an emerging economic tailwind when terror struck in 2001; today, there’s only a headwind—a strong headwind and one that’s likely to blow harder in the months ahead.

Nor can the sharp pullback in spending be blamed on income, which rose 0.3% last month, up from September’s meager 0.1% gain. The chart above suggests that consumers are now committed to saving more and spending less. In one respect, that’s encouraging. The savings rate in the U.S. has been falling for years, largely because consumption has taken wing. Those trends are now reversing, as they eventually would. In the short term, however, the implications are clearly negative for the economy, which is highly dependent on consumer spending to the tune of about 70%. As such, the sharp pullback in consumer spending hints that Q4 GDP will be materially worse than the Q3 pullback of -0.5%.

Corroboration for this dark outlook comes in today’s update on new durable goods orders, which slumped by more than 6%–the biggest monthly decline in two years, and the third consecutive month of red ink. Virtually every measure of new orders shrunk, from machinery and fabricated metals to transportation and capital goods. No one, then, will be shocked to learn that the durable goods component for personal spending submerged by a heavy 4.0% last month.

All of this might be manageable if other areas of the economy were holding up. Again, we’re out of luck. Notably, the real estate market continues to correct. New home sales were down again by a robust 5.3% last month. Expectations for a quick turnaround, or even treading water still looks unlikely based on the ongoing decline in forward looking measures such as new housing starts and new building permits issued.
Unsurprisingly, the labor market is still bleeding as well. Last week’s tally for initial jobless claims was again north of 500,000, a red zone that suggests that the workforce will continue to shrink for the foreseeable future.
As the economic pressures mount, so too does the government’s efforts to ease the pain. Yesterday, the Federal Reserve announced yet another massive spending plan for supporting the economy. The immediate effect was a big drop in mortgage rates. The average 30-year fixed mortgage dropped to roughly 5.5% from 6.38% yesterday, according to Bloomberg News. Not bad for a day’s work in the stimulus trenches. And the incoming Obama administration is prepared to hit the ground spending when the president-elect moves into the White House in January.
But stimulus—or, rather, the economic recovery program–isn’t the magic pill it used to be. Even with all the current and future liquidity, Joe Sixpack isn’t likely to take the bait, at least not just yet. One could argue he’s been over stimulated one too many times in the past and so the charm’s worn off. Eventually, the explosion of 0% financing offers and government rebate checks will change the negative sentiment, but not anytime soon, as the glum news on consumer sentiment warns.
The Reuters/University of Michigan Surveys of Consumers’ index fell to a 28-year low this month. “Consumers were unanimous in their recognition that the economy was in recession, and nearly three-in-four expected the recession to deepen in the months ahead,” the report said via Reuters.
When it comes to consumer spending, perception is reality. Yes, the government’s efforts will help, but primarily by keeping a deep recession from turning into a catastrophe. A big part of the solution time around is that the correction will have to run its course. First among equals on the victim list: the notion that the Great Moderation was something more than a passing phase.