The Party's Over With interest rates on the rise, gas prices at record highs and wage growth tepid, consumers face strong headwinds
(MONEY Magazine) – The Federal Reserve has signaled that it is likely to raise interest rates, just as energy and consumer prices are rising. The fiscal stimulus provided by the Bush tax cuts is ebbing. And although 625,000 jobs were added in March and April, increases in salaries and wages remain alarmingly subdued.
I talked to Merrill Lynch chief North American economist David Rosenberg about how our nation's economic outlook is changing and how he expects consumers and investors to fare through the remainder of the year.
DOBBS: Let's begin with jobs. Will the recent improvement last?
ROSENBERG: Most of the leading indicators are telling us that we have turned the corner on the employment side. [But] I'm not necessarily convinced that we're going to be seeing the very strong numbers continue. To me, the more important aspect is not so much the employment side but the income side.
Q. How are we doing on that front?
A. Even with these very large [non-farm payroll] numbers, real wage and salary income in March was down 0.1%. Average weekly earnings were up 0.3% in April, but it looks like consumer prices rose about 0.3% as well. So my sense here is that real income growth is actually still rather subdued. I think the critical thing for the consumer is that even though income growth is rising in nominal terms, it's barely keeping up with the increases in life's necessities: medical care, food and energy.
Interest rates are backing up, and the fiscal stimulus is basically over. You tack on higher energy prices and this headwind ahead for the consumer comes to about $180 billion between now and the end of the year at an annual rate.
Q. Gasoline prices are now at a record high. Oil is moving above $40 a barrel. What will the impact be on both the consumer and the investor?
A. In terms of the investor, it's a classic case where higher energy prices would be good news for the energy sector, but they're a margin crimper for a lot of other industries. And although energy use in the United States as a share of GDP [gross domestic product] has gone down over time, it's still very significant for [some] individual sectors.
If these gas prices are sustained, they could easily shave half a percentage point off of GDP growth. You're talking about the difference between this year being in the high fours and the low fours. But half a percentage point on a $10-trillion-plus economy isn't exactly chump change.
In terms of the consumer, there is an old rule of thumb that every penny at the pump drains $1.3 billion out of the pocketbooks of consumers.
Q. Fed chairman Alan Greenspan has made it clear that the low-interest-rate party is over. What do you expect in the way of interest-rate hikes?
A. It's one of these things where the central banker takes the punch bowl away from the party. The way I see it, he's going to get rid of the rum and replace it with some malt beer. I think he ultimately takes the federal funds rate to between 2% and 3%.
This is not going to be 1994, when the Fed shifted to a tight stance to curb potential inflation pressures. Keep in mind that by the time the Fed started tightening in 1994, we had created 5 million jobs. This time around we've created 1 million jobs from the low. And the inflation pressure in the system is a lot less intense. My sense is that this will go down in history as one of the mildest tightening cycles on record.
Q. What typically happens in a tightening cycle?
A. Since the Volcker era of the 1980s, they tend to last about 14 months. Typically the Fed funds rate, on average, goes up 250 basis points [2.5 percentage points].
My sense is that this time around the cycle is going to be a lot shorter and less intense, because we still have excess capacity in the goods and labor market and very low measured rates of inflation, and the money-supply growth numbers are very well behaved. And the reaction of the markets is so much swifter these days compared with the past. If you look at how the financial markets have reacted, [interest rates have risen] almost 200 basis points just in the past two months.
I've been covering the markets, the Fed and the economy for 20 years, and this is the first time I have seen a complete tightening cycle priced in by the futures market and the bond market before the Fed has even lifted a finger. So I think fears about what will happen in the markets when the Fed actually raises rates are overdone.
Q. With record gasoline prices, rising energy prices, the prospect of higher interest rates and excess capacity in the labor market, how do you see the consumer and the economy holding up for the rest of the year?
A. At this time last year we were seeing tremendous fiscal stimulus, we were seeing tax cuts, we were seeing dramatically lower mortgage rates, tremendous equity extraction out of the home via mortgage refinancing, and energy prices were 50% lower than they are today. So you have to add all that together and it's a tug-of-war. It's good that we're seeing job growth right now, but there are a lot of these other offsets.
Q. How do you expect the economy to affect the presidential election?
A. Well, it's one of these things where generally, if you look in the past, you tend to find that around this time of the year--March, April, May--that the economy has the primary impact on the November election. So, right now, with just economic data, it's not looking too bad for the President.
Q. How's it looking for the rest of us?
A. I think that we have a lot of headwinds ahead of us. [But] are we better off than we were 12 months ago? In terms of the aggregate economic statistics, well, there's no question about that.
Q. But on election day the question will be, are we better off today than we were four years ago?
A. That's an individual decision. I'll just leave it at that. It comes down to what industry you're employed in and what stocks you own.
DOBBS: And, of course, your political party, views about Iraq, the war on terrorism, trade, outsourcing, education and a host of other issues that make up our political economy. Let me be among the first to say, be sure to vote.