Consumer Confidence Is At A 17 Year High

Housing Prices Headed Up?

Let’s look at the housing market. It’s important for housing prices to increase in a steady manner to help people’s net worth improve. As we’ve discussed, savings rates are down and real earnings growth has been stagnant for non-supervisors. The wealth effect might just be all we have to keep the economy going. I don’t have a sensitivity analysis to show the exact effect asset prices have on the consumer, but consumer spending would be lower if stocks were down 10% instead of where they are now year to date. It’s the same with housing. The economy doesn’t rely on housing the way it did in 2005, but it’s still important. Luckily, the chart below indicates the price of housing will continue to increase because lumber futures are up. As you can see, the lumber futures have been a great predictor of the Case-Shiller 20 city price index. The lumber prices fell before the housing bust and rose before the recovery started. There was a false alarm in 2014-2015 as lumber prices fell along with the other commodities.

Consumer Confidence Explodes

The chart below shows the consumer confidence compared with the household debt service ratio. As you can see, the consumer confidence survey tends to peak right before recessions. I don’t necessarily think another recession is coming just because confidence is high. We’re in an unusually long business cycle. I expect the expansion to last at least another year. However, the important point to recognize is the high consumer confidence index doesn’t mean the economy is about to see amazing growth. The chart shows the household debt service ratio is diverging from the confidence survey this cycle. That’s because the debt taken out via mortgages hasn’t rebounded like other debt has.

To be clear, on Tuesday the consumer confidence indicator showed a 125.9 reading. That was above the consensus of 121.0, above the prior reading of 119.8, and above the highest estimate which was 122.9. This report was a 17 year high. The key improvement in this survey was from the labor market where only 17.5% of respondents said jobs were hard to get. This is a good sign for the labor report on Friday. There was also a high amount of optimism on the stock market as 42.1% were bullish and 23.2% were bearish.

This leads us to the biggest criticism of the report. The critics argue confidence is only up because the stock market is up. If it simply tracks the stock market, it would be silly for stocks to rise on news that confidence is up. That would be circular logic. The correlation between the S&P 500 and consumer confidence is 96% since 2010 and 76% since 2006. This doesn’t prove the stock market is the only thing confidence is affected by. As you can see from the construction of it, the labor market also matters. However, critics will point out that these amazing numbers haven’t led to amazing spending reports. We’ll see this holiday season if this trend continues. Plans to buy autos increased by 1% to 13.1% because of the hurricanes. That did correlate with improved sales results in September. On the other hand, the inflation expectations fell 2 tenths to 4.7%. Obviously, inflation will never get to 4.7% this year, but the point is that inflation expectations fell. I still think inflation will pick up in the next 6 months.

 

Europe Also Confident

Besides the improved confidence from the American consumer, the European economy also has seen improved sentiment. The chart below shows the services confidence, industrial confidence, economic sentiment, and consumer confidence are all at or near their cycle highs. This led the ECB to cut its QE program in half for the first 9 months of 2018. The scary part of this program is that the ECB is still doing it at all with such high sentiment. Combining that with NIRP seems to be overly stimulative. In the next few years, we’ll see what unintended consequences the excessive stimulus chasing inflation brought the economy.

In the past few months, I’ve discussed the divergence between the German inflation rate and the European inflation rate. The point I made was that the ECB wasn’t going to stop QE and NIRP just because one country saw inflation above the 2% goal. The Bundesbank was critical of this policy when Germany was feeling the heat. However, the most recent German CPI report showed consumer prices fell from 1.8% in September to 1.5% in October. That’s right at the E.U.’s inflation rate as of the September report. This means there will be less conflict between the ECB and the Bundesbank. This also means there might be a turn towards deflation without the full strength of the QE program in 2018. Spain’s inflation fell from 1.8% to 1.7%.

The chart above showed inflation as of September because that chart is a day old. The chart below shows the latest data which was released on Tuesday. As you can see, inflation fell from 1.5% to 1.4%. This is bad news for the ECB as it just did a major tapering which starts in January. The core inflation was 0.9% which was below last month’s report of 1.1% growth. It was the first time in 5 months where core inflation was below 1%. Alongside this disappointing report was good news. GDP growth was 0.6% on a quarter over quarter basis and 2.5% year over year which is the highest growth since 2011.

Conclusion

The inflation data coming out of Europe looks bad for the ECB as it is far from its 2% goal as it ends the QE program in late 2018. The choice is to either push towards the goal which runs the risk of creating financial bubbles or stop QE which runs the risk of inflation dipping further. The ECB made the latter choice. This means Europe might have deflation in the next couple years if all the trends remain in place. The demographics of Europe mean interest rates will naturally fall.

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