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Daily Global Commentary

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Recession Will Be Led By Steep Decline in Consumer Spending

Mon, Oct 13 2008, 14:06 GMT
by Asha Bangalore

Northern Trust

Recession Will Be Led By Steep Decline in Consumer Spending

Retail sales fell 1.2% in September following declines in each of the prior two months. The three consecutive monthly declines amount to a 4.0% annualized drop in headline retail sales, the largest quarterly drop since the first quarter of 2002.

All major components of retail sales posted a drop in sales during September, with the exception of a 0.1% increase in gasoline and a 0.4% gain in the health and personal care component. Overall consumer spending in the third quarter, which includes goods and service, is most likely to record the first quarterly decline since the fourth quarter of 1991. Consumer spending held up during the 2001 recession. Financially strapped households with weak employment conditions are not in a position to go on a spending spree in the near term.

In addition, net worth of households will show a large setback in the third quarter due to lower home prices and a sharp decline in equity prices. The decline in net worth in the third quarter will mark the fourth consecutive quarterly reduction. It is worth noting that during the three quarters ended in June 2008, household net worth has fallen $2.69 trillion compared with a $3.19 trillion decline in net worth during the 2000-2002 period. In other words, the latest three-quarter drop in net worth is a staggering 85% of the reduction in net worth which occurred over a three year period. With projections of additional declines nearly certain, the likely adverse impact on consumer spending in the quarters ahead is most likely to be significant.

Households are already burdened with enormous debt obligations (see chart 4) and the amount of personal saving available for funding any shortfall is negligible (see chart 5).

The bottom line is that consumer spending will take several quarters to gather momentum. The resolution of the financial and credit issues will be necessary before a rebound in economic activity is visible. Chairman Bernanke’s depiction of the outlook for the economy in his address to the New York Economic Club today best describes what is in store.

"Stabilization of the financial markets is a critical first step, but even if they stabilize as we hope they will, broader economic recovery will not happen right away. Economic activity had been decelerating even before the recent intensification of the crisis. The housing market continues to be a primary source of weakness in the real economy as well as in the financial markets, and we have seen marked slowdowns in consumer spending, business investment, and the labor market. Credit markets will take some time to unfreeze. And with the economies of our trading partners slowing, our export sales, which have been a source of strength, very probably will slow as well. These restraining influences on economic activity, however, will be offset somewhat by the favorable effects of lower prices for oil and other commodities on household purchasing power. Ultimately, the trajectory of economic activity beyond the next few quarters will depend greatly on the extent to which financial and credit markets return to more normal functioning."

Weak Economy Trumps Increase in Core Wholesale Prices

The Producer Price Index (PPI) of Finished Goods fell 0.4% in September following a 0.9% decline in the prior month. The 2.9% decline in the energy price index was largely responsible for the drop in the overall price index. Food prices advanced 0.2% in September vs. a 0.3% increase in August. During the first nine months of the year, wholesale prices have risen at an annual rate of 7.9% compared with a 6.2% gain in 2007. The energy price index has moved up 16.7% in the first nine months of the year vs. a 17.8% gain in 2007. The recent sharp drop in energy prices points to further declines in energy prices, particularly given the projections of weak economic conditions across the globe. The food price index has advanced 7.5% in the January-September period, nearly matching the increase seen in 2007

The core PPI increased 0.4% in September, led by higher prices for cars, light trucks, and medicines and a 0.5% increase in the capital equipment price index. The fragile status of the economy suggests that these gains in core prices are probably temporary. Intermediate and crude goods prices fell in September. The core intermediate goods price index rose 12.1% from a year ago in September, which is a noteworthy deceleration from a 12.5% increase in August, most likely the peak for the current cycle.

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Published on  Wed, Oct 15 2008, 22:31 GMT