The Fed Weighing Low Wage Growth On Consumer Spending Outlook

by: RadaEcoWatch

Summary

Over the next week investors' attention will be on the testimony of the Fed Chair Janet Yellen before the Banking Committee of the Senate on Tuesday 14th.

We think that the results of the January labor market report will take center stage, with falling wages growth raising concerns on the consumer spending outlook.

Despite the decline in real wages growth in recent months, the short-term outlook for consumer spending remains positive.

However, we think that the consumer spending trend could soften over the next few months if it is confirmed by the weakening of real wage growth.

In this scenario, the Fed could decide to raise rate at slow pace in 2017.

With President Donald Trump unveiling his tax incentive plan in a couple of weeks, over the next week investors' attention will be on the testimony of the Fed Chair Janet Yellen before the Banking Committee of the Senate on Tuesday 14th. We expect Yellen to give more indications on the outlook of monetary policy. In December, Fed members projected three hikes rates by 25 points in 2017 and the fed fund futures are now discounting only two rate hikes.

We think that the results of the January labor market report will take center stage. Indeed, while the 227k new jobs creation and the 4.8% unemployment rate confirmed the positive outlook for labor market, the decline of yearly average wage growth from 2.8% to 2.5% y/y increased concerns on the outlook of consumer spending, which represents 69% of US GDP.

Indeed, low wage growth over the next few months could have a negative impact on consumer spending due to the recent increase of inflationary pressures. In December 2016, the consumer price index rose by 2.1% y/y, up from 1.7% y/y in November, and the CPI core rose 2.2%. January data, due on Wednesday the 15th, should see an increase to 2.4% y/y for the negative base effects on energy prices, with the CPI core unchanged at 2.2%. According to Bloomberg's consensus estimate, the CPI is expected to rise from 1.3% in 2016 to 2.4% in 2017.

In this scenario, the spread between wage growth and inflation could post a new low since July 2013, weighing on future consumption. Despite the decline in real wage growth in recent months - from 1.8% in July 2016 it has dropped to an estimated 0.1% in January - the short-term outlook for consumer spending remains positive. The drop in the unemployment rate and the good momentum of the labor market, in fact, are supporting consumer confidence. Both the Conference Board index and University of Michigan results are close to their highest levels since 2008, anticipating a sustained growth in consumption in the first three months of the year.

However, we think that consumer spending trend could soften over the next few months if it is confirmed by the weakening of real wage growth. Indeed, real wage growth is a good leading indicator of consumer spending 1 year in advance. Therefore, consumer spending could grow at moderate pace in early 2018, with a negative effect on the whole economy.

Brisk short-term outlook for consumer spending and corporate investments, in line with the sharp rise of both consumer and business confidence indices over the last few months, should strengthen the positive expectations of the Fed members on economic growth. However, we think that the Fed will maintain a wait-and-see stance in the short term to assess the economic outlook and the impact of Trump's fiscal policy. We expect the Fed to keep rates unchanged in March, with the first rate hike for 2017 decided in June, when the outlook for wages growth in the coming months will be clearer. If wage growth resumes a positive trend, the Fed is likely to raise rates as projected in December '16. Otherwise it could decide to do so at slower pace.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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