Consumer spending up, helped by job market

INDICATOR: February Income and Spending

KEY DATA: Consumption: +0.7 percent; Inflation Adjusted: +0.3 percent; Disposable Income: +1.1 percent

IN A NUTSHELL: "The improving job market is overcoming tax increases, allowing incomes and spending to rise."

WHAT IT MEANS: Surprise, surprise, households are still spending money like crazy. Consumption rose sharply in February on top of a solid gain in January. Importantly, demand for services, which is two-thirds or all spending, is starting to show signs of life. This component had been moribund for a long time and it is hard to post large increases in consumer demand if the bulk of spending is weak. Households also spent money at retail stores but largely flat vehicle purchases kept down gains in the durable goods purchases. The rise in demand was powered by a strong increase in income. Businesses had loaded bonuses and dividends into the end of 2012 in order to beat the expected tax increases so it was not surprising the January's income was down a lot. There was some negative impacts in February as well, which makes the large rise in disposable income so impressive. You can create rising wage and salary income from either higher wages or more people working and while the wage gains are slowly improving, it was the jump in jobs that powered the income increase in February. Also, improving corporate balance sheets are leading to increased dividend payouts and that helped dramatically as well. There was so much income added during the month that despite the rise in spending, savings and the savings rate rose. So, we had rising income, rising spending and rising savings. You can't ask for much more.

MARKETS AND FED POLICY IMPLICATIONS: Do tax increases slow an economy down? Of course. But other factors are at work now and they are overcoming the negative impacts of the fiscal cliff deal. Whether the spending can be sustained is a wholly different issue. The effects of ending the payroll tax holiday will build, especially for lower and middle-income households. Indeed, the savings rate did increase but the level is still quite low, indicating some households may already be dipping into their rainy day funds. Second, sequestration is likely to mean furloughs for government workers. That will lower incomes and slow spending. Reduced federal spending will be felt by government suppliers who will have to cut back, lowering incomes and demand. While it may look right now as if there have been few negative effects of the government's attack on the economic recovery, wait a while. It is coming. The point is, we could have had really strong growth if negative fiscal policy hadn't gotten in the way. As it is, growth will continue, but be more moderate and if the sequestration lasts the whole year, it could be disappointing especially when compared to what it might have been. As for the markets, they are closed today but investors should be buoyed by the strong data.