Crunch Time For The Business Cycle

If there’s one corner of the economy that concerns me more than others, it’s the recent trend in disposable personal income (DPI). As I discussed last month with the update of the November data, the falling pace of annual growth is starting to look troubling on this front.

DPI is a crucial factor generally for the consumption-dependent U.S. economy. Any one month isn’t all that important, but the trend is another matter. As the authors of Conquering the Divide: How to Use Economic Indicators to Catch Stock Market Trends advise, DPI is “the amount of money consumers have available to spend after paying income taxes.” As a result,

The rate of change in disposable income offers insight into the balance sheet of the consumer. As income increases, spending should follow and economic growth should be healthy. Decreasing incomes are signs of potential recessions.

Analysts expecting a new recession in 2012 are still in the minority, but they’re a persistent lot, as I noted yesterday. One of the stronger arguments for worrying surely resides with the diminishing growth rate of DPI. The annual change was a modest 2.4% as of November, the latest update. A year earlier, in November 2010, DPI was advancing twice as fast at a 4.8% pace on a year-over-year basis. Other than during the Great Recession and its aftermath in 2008 and 2009, the current rate is near the lowest levels on record, which starts in 1959. Not a good sign for looking to the year ahead.

The speed of the decline in the annual rate of growth in DPI is the primary concern. It’s been unfolding for some time and so it’s hard to dismiss the weakening trend as statistical noise. The slowdown has obvious implications for consumption. Speaking of which, on Thursday the government releases the December reading for retail sales, which are expected to post a handsome rise of 0.5%, according to the consensus forecast via The optimism seems warranted, at least for the moment, given the generally favorable increase in holiday sales.
But there’s a sizable and growing gap between DPI and retail sales, with the latter rising at a much faster pace. If the squeeze on disposable income rolls on, there will be repercussions for consumption, which inevitably will spill over into the broader economy. The question is whether the recent strength in the labor market will save us from this train wreck? A stronger rate of job growth is the critical tonic that’s needed to keep DPI’s trend from sinking further if not mounting a revival.
On that note, Thursday also brings word of the latest on the weekly report on initial jobless claims, which have been falling recently. The hope is that the drop in claims is a reliable signal of stronger job growth in the months ahead. Nothing less is needed to offset the deterioration in DPI. The folks telling us that there’s a new recession approaching are effectively saying that initial jobless claims aren’t a dependable harbinger of things to come. They may be right, but if there’s any hope for avoiding a downturn, a stronger labor market is surely on the short list of potential saviors.
The good news is that it’s too soon to throw in the towel on seeing a way out of this mess. Private nonfarm payrolls rose 1.8% in December vs. a year earlier. That’s a decent increase by the standard of the last several decades. More importantly, the annual pace has been rising. At the end of 2010, the year-over-year increase was just 1.1%. If there’s another recession coming, we’ll probably see the private sector labor market’s current 1.8% year-over-year growth rate take a dive lower in the months ahead.

For now, however, the latest numbers tell us the labor market is improving, a trend—if we can keep it—that will go a long way in putting the recession forecasts on the defensive. But we’re at a point where there’s minimal, if any, room for bad news.