July Personal Income, Spending, and Inflation

Personal income plunged more than expected in July, falling -.7% MoM (consensus -.2%, prior +.1%). This was the first drop in incomes since mid-2005. In contrast spending rose +.2% MoM, as expected, but at a slower pace than the +.6% rise in June. All three inflation indicators rose as expected, with headline PCE inflation rising +4.5% YoY, to the highest level since the early 90s. This was a rapid rise from the 4% pace observed in June, which was revised down from the 4.1% rate previously announced. Core PCE, which looks at the Fed’s preferred personal consumption expenditures after food and energy, rose +.3% MoM, the same pace as June, and rose to +2.4% YoY from 2.3% the prior month. This was the largest annual increase in core PCE since early 2007. Over the past year, personal income has risen +4.2% while personal spending has grown by an even larger +5.3%. The savings rate in July was 1.2%, down from 2.5% last month and 4.9% in May, but still up from the +.2% in March and April before the stimulus checks began. Within personal income, compensation rose +.3% MoM, as did wages and salaries. But disposable income, which is after taxes, fell -1.1% MoM, reflecting the ending of the tax rebate check stimulus. Excluding stimulus payments, disposable income would have risen +.5% MoM. When income is adjusted for inflation, it fell -1.7% MoM, an improvement on the -2.6% MoM pace of June. When adjusted for inflation, spending fell -.4% MoM, the largest drop in four year. By category, inflation adjusted spending on discretionary durable goods fell -1.6% MoM, while spending on non-durables, such as food and gasoline fell -.9% MoM in inflation adjusted terms. Spending on services were constant. Consumer spending accounts for 2/3rd of GDP. With incomes falling, and the economy slowing, the consumer is not in good shape, which is bad for spending in the next few months. It is estimated that the longest expansion in consumer spending will end this year. There is a chance that real personal spending could fall in the third quarter for the first time since 1991.

Univ of Michigan Confidence rises modestly in August

The final University of Michigan consumer confidence measure rose a point to 63 from the preliminary 62 estimate, as lower oil prices have helped the index recover from a low of 56.4 in June, and 61.7in July. Last year, the index averaged 85.6, so sentiment remains depressed. Both current conditions and the future outlook rose in the final revision, with current economic conditions coming in at 71 (vs 69.3), but below July's reading of 73.1, and the economic outlook rose to 57.9, from the preliminary estimate of 56.8. For comparison, the economic outlook was at 49.2, when the index bottomed in June, while the current conditions was at 67.6. Inflation expectations held steady at their preliminary August readings of 4.8% for 1-year ahead ,and 3.2% for 5-year ahead. These readings compare to May's high readings of 5.2% and 3.4%.

Chicago Purchasing Manger Index Rises Most in a Year

The Chicago Purchasing Manager index of nationwide business conditions jumped to 57.9 in August, versus 50.8 in July, for the highest reading since June 2007. Any reading above 50 indicates growth.

Big increases in production (63.4 vs 49.2, and fastest rise in 4 years), new orders (60.2 vs 53.5, and highest level in almost a year), and order backlogs (63 vs 45.7), offset a small decline in inventories (52.2 vs 54.9) and a big drop in the employment index from 45.9 to 39.2.

Businesses also took note of moderation in fuel costs, as the price index fell 10 points to 80.6, a 6-month low, after reaching a ten year high last month

The stregth in the Chicago index is at odds with the other regional surveys, especially when you consider the heavy weeighting of the auto industry in this regional survey. But, export demand clearly remains strong for the machinery produced in the Midwest.

Today's Tidbits

Gross Domestic Income Weakness Suggests Recession

From Merrill Lynch: “GDI is an alternative measure of economic activity calculated using income rather than production. Nominal GDI grew by 3.3% QoQ, annualized in the second quarter versus nominal GDP growth of 4.6%. Adjusting the income series to a real measure brings the series down to 1.9% and also shows that, in contrast to GDP, the series has already posted two consecutive quarters of negative growth - the lay man's definition of a recession - since the fourth quarter of 2007….In 2007, the Fed published a paper … the author noted that "the growth rate of gross domestic income (GDI), deflated by the GDP deflator, has done a better job recognizing the start of recessions than has the growth rate of real GDP. This result suggests that placing an increased focus on GDI may be useful in assessing the current state of the economy." …The GDI data suggest a much weaker pattern of growth over the last four quarters than does the GDP measure (and indeed since 2007). With history showing that the Fed watches both GDI and GDP, when the two diverge, the relative weakness of GDI to GDP suggests the Fed will look past the upward revision to 2Q GDP and focus on the outlook, which in our view, is likely to show two quarters of negative GDP growth beginning in 4Q of this year.”

MISC

From BMO: “…yesterday’s strong durable goods orders report suggests business capex might be turning up, possibly because of the accelerated depreciation allowance contained in the fiscal stimulus package.”

From Bloomberg: “Crude oil fell more than $2 a barrel after the International Energy Agency said it would tap strategic stockpiles, if needed, because of Tropical Storm Gustav.”

From MNI: “China's fiscal revenue in the first seven months to July grew by 30.5 pct year-on-year to 4.088 trln yuan…”

From MNI: “Bank of China Ltd said the carrying value of is US subprime mortgage-related debt securities was 3.64 bln usd at the end of June, or 1.5 pct of the bank's investment securities.”

End-of-Day Market Update

From Suntrust: “Odds were against Treasuries today. Jobless claims fell 10k, the third weekly drop, though continuing claims climbed 64k. First revision to GDP pushed growth in Q2 to 3.3% vs 1.9% originally reported. Skeptics poo-poo the number because 3.1% of the 3.3% growth was due to exports and foreign trade. Still, the US economy muddles along out of recession territory. 2-year notes fell 3 ticks, 10-yr notes swooned 10 ticks before hitting a bottom. Then the $22 bln 5-yr Treasury auction was sloppy. The yield tailed back to 3.129 vs an expected stop of 3.11. Indirect bidders took 29.8%, below 33% in July, but slightly above average for the last 6 months. No worries, because like recent days, sneaky buying returned in the afternoon on any price dips. Again, chalk it up to month-end needs. The 30-yr has erased all losses and is higher on the day by 6 ticks. The mortgage market is outperforming Treasuries, also benefitting from month-end. The 5-yr note auctioned at 3.129 turned out to be a "dutch treat", trading now at a 5 bp profit. Relief is apparent now that supply is over and done with.”

From UBS: “The Treasury today auctioned $22B in new 5-year notes at a 3.129% yield, tailing the 1pm level by 1.6bps. Indirect bidders accounted for an above-average 29.8% of the auction, and the bid-to-cover ratio was 2.14x, roughly in line with the recent average. The market had spent most of the day selling off prior to the auction on the back of last night's MBIA and Fannie headlines (which helped stocks higher), but bull-flattened immediately after the auction results were announced. This development suggests that some traders were already doing tomorrow's month-end index extension trades today, thus converting a good 3-day weekend into an even better 4-day one. Besides extension trades, we saw 2-way flow in intermediates, central bank selling of 1-year paper, and fast money selling of 2's. The 2s30s curve had 5bps bear-flattened by 3pm. Crude tumbled as much as $4+/barrel intraday after the IEA said that they'd release crude oil if Gustav disrupts production. Today's Treasury volume was another solid day at 112% of the 30-day average…Bloomberg News reported today that we do have one growth industry - the FDIC is adding 5 floors of new office space in Dallas to prepare for more bank failures. Oh joy…Swaps saw receiving in the belly, and spreads continued to narrow. Agencies had a sleepy Thursday, cheapening to Libor in the back end and richening in front. The best performer of the day was the cheap 3-year sector. Mortgages saw early overseas selling, followed by afternoon buying from servicers and month-end extenders wishing to take tomorrow off. Mortgages went out at their tights of the day-- 11 ticks better to Treasuries and 9 to swaps.”

From Bloomberg: “The S&P 500 gained 15.58 points, or 1.2 percent, to 1,297.24 at 3:27 p.m. in New York. The Dow Jones Industrial Average increased 184.42, or 1.6 percent, to 11,686.93. The Nasdaq Composite Index added 24.82 to 2,407.28. More than four stocks rose for each that fell on the New York Stock Exchange. The S&P 500 extended its August gain to 2.4 percent and wiped out losses from earlier in the week… The Dow average's 2.8 percent gain in August makes it the third-best-performing stock measure in the world this month, in dollar terms, and the S&P 500's advance is No. 4., according to data compiled by Bloomberg. Three of the biggest gains in the S&P 500 today were MBIA Inc., Fannie Mae and Freddie Mac, which have all lost at least 22
percent this year.”

Three month T-Bill yield rose 6 bp at 1.73%
Two year T-Note yield rose 3 bp to 2.36%
Ten year T-Note yield rose 2 bp to 3.78%
30-year FNMA current coupon fell 4 bp to 5.75%
Dow rose 213 points to 11,715
S&P rose 19 points to 1301
Dollar indexrose .16 points to 77.21
Yen at 109.6
Euro at 1.469
Gold rose $7 to $833
Oil fell $2.70 to $115.5

2nd Qtr Real GDP Revised Up to +3.3% Annualized

The second revision of 2nd quarter real GDP was much stronger than expected, rising +3.3% QoQ annualized, versus a consensus expectation of +2.7% and an initial reading of +1.9%. This compares with real GDP growth of +.9% in the first quarter, and was the largest quarterly gain since the second and third quarters of 2007 when real GDP grew +4.8%.. Over the past year, real (inflation adjusted) GDP rose +2.2%, down from 2.5% in the first quarter. (Note – all these 2nd quarter data are reported as quarterly annualized, unless otherwise identified.) Personal consumption was also revised higher than expected to +1.7% annualized from 1.5% originally reported in the original preliminary update. Consumer spending is important because it accounts for about 2/3rds of US GDP. The rise in personal consumption from the +0.9% pace of the first quarter is probably due to the impact of the stimulus checks. Most of the rise in personal consumption was in non-durable goods, +4.2%, which probably reflects higher energy prices. Expenditures on services grew a more modest +1.3%, while durable goods consumption fell -2.5%, mainly due to lower auto sales. The fall in durable goods consumption is actually an improvement from the -4.3% decline of the first quarter. Real final sales were revised up to 4.8% from 3.9% in the first report. This is a substantial rebound from the sub 1% growth of the 4Q07 and 1Q08 pace. Core PCE (personal consumption expenditure) inflation held steady at +2.1%, as expected. But the headline GDP price index rose to 1.2% from the original estimate of 1.1%. As expected export growth was revised higher to 13.2% from 9.2% previously. In addition, imports fell more than expected by -7.6% versus +6.6% in the initial update. This caused net exports to become an important contributor to real GDP being revised higher. Record exports have helped offset the weakening domestic demand for goods and services. Excluding trade, the economy would have expanded at only +.2% in the 2nd qtr, and only +.1% in the 1st quarter. Unfortunately the boost from foreign demand may wane later this year as European and Asian economies also slow. Inventory investment was revised higher as inventories fell less than expected from -$62.2B in the initial forecast to -$49.4B in the second preliminary revision. This compares to -$10.2B in the first quarter. Higher state and local spending was the largest contributor to slightly higher government expenditure. Residential investment continues to be a significant drag on growth, falling -15.7%, while non-residential investment on structures rose +2.2%. Both figures were revised down by a tenth. Profits continued to decline in the second quarter, falling -2.4% compared to -1.1% in the first quarter. Corporate earnings are down 7% versus a year ago, the largest annual decline line the recession of 2001. For employees, real disposable personal income is now estimated to have fallen -.7% annualized in the first quarter, and to have risen +11.4% in the second quarter due to the rebate checks. Big picture, wages are not keeping up with inflation.

Continuing Jobless Claims Head Higher Again

Initial jobless claims fell for the third week in a row after hitting a four year high earlier this month after new extended benefits eligibility increased demand over the summer. Actual new claims fell to 425k, with the four week everage remaining elevated at 440k. This compares with a year-to-date average of 375k. A year ago, initial claims stood at 332k. Clearly, the slowing employment market is raising joblessness. Continuing claims continue to rise to a new high of 3.423 million, an increase of 64k from last week, and up 850k from a year ago, as the insured unemployment rate eased up a tenth to 2.6%.