One Reason Why Tapering Remains Unlikely

From our friends at the Consumer Metrics Institute:


Last month we mentioned that the BEA's earlier first estimate for 3Q-2013 (a 2.84% headline) was a "Goldilocks" moment: not so weak as to elicit real concern, and not so strong as to suggest the Federal Reserve re-thinking its QE stance. But at face value the new headline growth rate of 3.60% has arguably moved out of that "Goldilocks" zone -- and if the Fed was looking for "cover" for tapering, a growth rate above 3.5% would certainly qualify. In fact, under normal circumstances a 3.60% growth rate would indicate a healthy economy and be sufficient cause to start dismantling an extended "Zero Interest Rate Policy" (ZIRP). But these are not normal circumstances:

-- Nearly half of the headline number came from growing inventories. Conventional wisdom has this component reversing itself in future quarters -- reverting to a long term net zero gain or loss. In fact, since 2006 the average annualized real contribution from inventories has been essentially zero (-0.02%). Bloated inventories have a tendency to normalize, and in coming quarters we can expect production cuts to accomplish just that. If during the next quarter the inventory number reversed while everything else stayed the same, the headline number would be less than 0.25%.

-- Employment numbers still provide no "cover" for Fed tapering or tightening.

-- Contributions to the headline number from consumer spending on goods, consumer spending on services and exports all weakened.

-- Real per capita disposable income is still down -0.86% year-to-date. And if households continue to normalize their savings rates over the next few quarters (just as they have over the past two quarters while attempting to move back towards the savings level "comfort zone" seen prior to the January FICA increase), those increased savings will have to come from reduced spending.

In theory the employment numbers and disposable income tell us how households are doing. Those numbers alone tell us that households are not doing well, and the consumer spending numbers just released by the BEA confirm that households are adjusting accordingly. And the BEA's average real per capita disposable income somewhat masks any impact from a shifting distribution of that disposable income among households -- i.e., the median year-to-date real per capita disposable income is almost certainly down more than the one percent shown in the average.

Unfortunately the inventory surge gives a "smoke and mirrors" feel to this report. Even the BEA's own bottom-line "Real Final Sales of Domestic Product" indicates that real growth is less than 2%. But we're guessing that Mr. Bernanke and his colleagues know that -- giving QE and ZIRP yet another lease on life.