WEEKLY ECONOMIC COMMENTARY
Stone & McCarthy Research Associates
WEEK OF FEBRUARY 21, 2012
Here we go again. Just as the economy seems to be building momentum, an old foe is poised to take some steam out of the growth engine. As was the case in early 2011, oil and gasoline prices are once again rising sharply. And like a year ago, the catalyst for the rise is coming from geopolitical tensions. In early 2011, it was the Arab Spring with Libya in the forefront that threatened to curtail supply and roil the oil market. This time, it is the saber-rattling over Iran that is doing much the same thing.
To be sure, the current oil price spike may not have as much of an impact on economic activity as it did during the first half of last year when growth nearly ground to a halt. Back then the economy was considerably more vulnerable than it is now. Housing was still in a free-fall, debt burdens were more onerous, a Japanese earthquake and tsunami caused severe supply disruptions, and the sovereign debt crisis had a more pronounced shock effect on the financial markets. And while the job engine was cranking up, the unemployment rate was nearly a full percentage point higher, sustaining an elevated level of job insecurity.
Still, the resumption of rising oil prices cannot be ignored. According to the Energy Information Administration (EIA), the price of regular unleaded gasoline jumped from $3.39 a gallon to $3.52 between the weeks of January 23 and February 13, and another increase almost certainly took place this week. As the chart shows, the price is well below the peak of nearly $4 a gallon reached in early May of last year, but it stands well above the $3.19 a gallon in effect a year ago. In March 2011, it hit the current level of $3.52 before moving up steadily to the May peak of nearly $4 a gallon. It was in March, however, that households began to feel the pain, contributing to a downshifting in spending over subsequent months. Retail sales increased by a negligible 0.2 percent in April after posting an average monthly gain of 0.9 percent from January through March and then stalled out completely in May when gasoline stations accounted for 11.65 percent of total retail sales. In 2010, that share was more than a full percentage point lower, at 10.45 percent.
Although other factors were at work, the slide in gasoline prices over the second half of the year contributed significantly to a recovery in consumer spending. By December, prices at the pump had fallen to $3.23 a gallon, lessening the bite on household budgets. During that month, service stations accounted for only 11.09 percent of retail sales. On a dollar for dollar basis, the spike in oil prices over the first five months of last year absorbed most, if not all, of the savings consumers received from the 2 percent payroll tax cut enacted in late 2010. The question is whether the extra cash derived from the extension of the tax cut this year - approved by Congress today (Friday) - will again be poured down the fuel tank. At this juncture, it's too early to tell.
Clearly, if gasoline prices soar to or above the $4 level, which many industry analysts believe, the impact will be palpable. The increase since the start of the year is already beginning to put a squeeze on spending budgets. In January, the share of gasoline to total retail sales rose to 11.20 percent from 11.09 percent in December, as the $605 million increase in service station sales accounted for fully 40 percent of the $1.53 billion gain in total retail sales during the month. Keep in mind though that disposable personal income is nearly $100 billion higher than it was last May, so consumers have more of a cushion to absorb a gasoline price increase than was the case then. Simply put, a $4 price at the pump would take less of a bite on household budgets, and less of a toll on discretionary spending. The January retail sales data highlights this prospect.
Overall, retail sales for the month rose by a disappointing 0.4 percent, well short of the expected gain of 0.7 percent or so. But the shortfall was due primarily to a surprising drop in auto dealer sales, which slumped by 1.1 percent. That fall-off, which follows a strong 2.5 percent increase in December, does not square with the muscular increase in unit car sales reported by the industry for the month. Sales of new light vehicles surged from 13.496 million in December to 14.133 million in January, which was the strongest selling pace since August 2009 when the "cash for clunkers" program was in effect. It may be that the sales mix during the month shifted towards lower priced vehicles, which might explain the discrepancy between unit and dollar sales. There is also a difference between the seasonal adjustment factors applied to unit versus dollar sales. In any event, the auto dealer component of retail sales tends to be highly volatile and subject to sizeable revisions in subsequent months, so the weakness in January may turn out to be more statistical than real.
More to the point, rising gasoline prices have so far not curtailed most other purchases. Retail activity in January excluding the volatile auto and price-driven gasoline components staged a solid 0.6 percent increase in January, driven largely by sales of full-priced merchandise, including those sold at department stores. One of our favorite barometers of discretionary spending trends is the propensity of households to eat at restaurants and other dining establishments outside the home. Here the evidence is compelling that frivolous spending has not yet been a victim of climbing gasoline prices. In January, sales at food services and drinking places rose by a solid 0.6 percent, lifting the year-over-year increase to 8.2 percent. An annual increase of that magnitude has not been seen since December 2006, a year before the onset of the Great Recession.
No doubt, the impact of climbing gasoline prices is being diluted by the unseasonably warm weather, which lowered the cost of heating homes in January. That cost won't be known until the January figures on personal incomes and consumption is released later this month, which will provide more detail on total energy expenditures, including heating. More important is that the report will also provide greater insight into how well incomes are holding up. By all accounts, household paychecks should be keeping pace with the climb in gasoline prices, reflecting the robust gain in net job creation last month as well as the longer hours put in by workers. The point to emphasize is that households are in better shape to withstand higher energy prices than they were a year ago, although some impact will surely be felt particularly if gasoline prices surge well beyond the $4 a gallon threshold.
Keep in mind too that household finances are steadily improving. The ongoing rally in the stock market, up more than 20 percent since October 1, is playing a role by boosting the value of household portfolios, including 401(K) holdings. Flusher nest eggs and a strengthening labor market combined with historically low mortgage rates and an array of government support programs may finally be succeeding in helping homeowners cope with the tidal wave of foreclosures that has crippled the housing industry since 2007. According to the Mortgage Bankers Association (MBA), the overall mortgage delinquency rate declined in the fourth quarter to its lowest level since the third quarter of 2008. During the period, the overall delinquency rate stood at 7.58 percent, down significantly from 7.99 percent in the third quarter and considerably below the 10.06 peak reached in the first quarter of 2010.
Significantly, the share of loans 30-89 days past due - often described as early-stage delinquencies - is down more than 100 basis points from its peak of 5.59 percent in the first quarter of 2009. In good part, this reflects improved mortgage underwriting standards of the past few years, but we believe it has more to do with the improvement in fundamental economic conditions, particularly on the labor front. Historically, early-stage delinquencies bear a close relationship with the unemployment rate as can be seen in the following chart. We expect this rate to decline further as the jobless rate continues to fall over the balance of the year.
That said, it will be a while before the foreclosure wave subsides. Although early-stage delinquencies may be falling, the pipeline of foreclosures remains almost filled. According to the MBA, the foreclosure inventory rate -- the share of all loans in the process of foreclosure -- declined only slightly in the fourth quarter, from 4.43% to 4.38%. That's off the peak of 4.64% set in the fourth quarter of 2010, but still quite elevated by historical standards. The average from the first quarter of 1979 through the third quarter of this year was 1.32%. Indeed, the foreclosure inventory rate of 4.38% in the fourth quarter translates into 1.879 million loans in the MBA survey. Another 1.523 million loans in the survey were 90 days or more past due in the fourth quarter. Using MBA's assumption that their survey covers 88% of outstanding mortgages, that translates into a total of 3.651 million loans either 90 days or more past due or in the process of foreclosure. Again, that's down from a peak of 4.865 million in the first quarter of 2010, but it is still a formidable shadow inventory of homes overhanging the market that will put downward pressure on home prices for some time to come. Progress is being made, but the housing industry is far from out of the woods.
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