Income went down but spending went up

The consumer seems to have shrugged off the impact of the rise in payroll taxes as spending rose in January. (AP Photo/Elaine Thompson, file)

INDICATOR: January Income and Spending

KEY DATA: Consumption: +0.2%; Disposable Income: -4.0%

IN A NUTSHELL: "So far, the increase in taxes has not stopped the consumer from spending."

WHAT IT MEANS: The consumer seems to have shrugged off the impact of the rise in payroll taxes as spending rose in January.  Or maybe, the full impacts on income just started to hit and people are taking time to adjust. I just don't know. Regardless, the feared slowdown in household purchases didn't occur.  Importantly, demand for services rose.  As I have often pointed out, you cannot get strong consumption growth if people don't buy services since this component makes up about two-thirds of all demand and 45% of GDP.  Let's hope people are starting to get back into the swing of things as we cannot expect vehicle sales to rise as rapidly this year as they have over the past couple of years:  We are not that far away from normal levels of sales.  Indeed, a modest pull back in vehicle purchases was the chief reason that consumption wasn't up more.  But where we go from here is a good question.  The sharp decline in income has to be taken with a grain of salt.  Many companies front-loaded dividend distributions last year in order to beat looming tax increases.  The biggest drop in disposable income did not come from the higher taxes paid for Social Security but in dividend income.  We will have to wait for the February numbers before we get a good handle on income but with wages and salaries down in January, I am not that optimistic.  At least prices are well contained so s income increases are not being lost to higher consumer costs.  Still, we started off the quarter on a decent footing and maybe that will continue despite the insanity in Washington.   

MARKETS AND FED POLICY IMPLICATIONS: The headline numbers were not that great but this was a surprisingly decent report.  Households are continuing to spend money and their confidence seems to be holding up: The Thomson Reuters/University of Michigan's confidence measure rose nicely in February.  That reinforces the strong rise reported by the Conference Board.  Clearly, the economy continues to move forward despite the Washington's incessant attacks on it.  Households seem to have taken a "cry wolf" approach to sequestration, believing that the wackos will not really do something crazy.   Let's hope that is true.  As for the markets, this report provides some comfort that cut backs in government spending will not crash the economy as long as consumers are willing to spend.  But if sequestration goes on for an extended period and the unemployment rate starts to rise, all bets are off.  The improving confidence could quickly turn around and take spending with it.