More Evidence of U.S. Economic Tailwinds, From Tax Cuts to Jobs

(Bloomberg) -- There’s more evidence now that U.S. economic tailwinds highlighted this week by Federal Reserve Chairman Jerome Powell are gathering strength.

Reports out Thursday showed recent tax cuts buoyed Americans’ spending power in January, unemployment claims fell last week to an almost five-decade low and factories expanded in February at the fastest rate since 2004. In addition, a key price gauge watched by the Fed rose in January by the most in a year.

The update on the economy comes as Powell faced lawmakers again following comments earlier in the week that “some of the headwinds the U.S. economy faced in previous years have turned into tailwinds.” Fatter wallets and a solid labor market signal inflation-adjusted consumer spending may pick up after falling in January, while progress on prices reaffirms that the Fed will opt for a widely expected rate rise this month -- and remain on track for at least two additional hikes this year.

The rise in disposable income “indicates some dry powder for spending to pick up,” said Michael Feroli, chief U.S. economist at JPMorgan Chase & Co. “Consumption got off to a weak start but it should pick up as tax cuts show up in paychecks.”

The price data “will add to the sense that the weak patch in inflation is behind us,” and “barring some kind of disaster, a March hike is pretty much a done deal,” Feroli said.

Real disposable income, or after-tax earnings adjusted for inflation, grew in January by the most since 2015 amid lower taxes and more bonuses related to the law, the Commerce Department reported. The data, covering the first month since the tax law was signed in December, reflected a $30 billion increase in one-time bonuses and a $115.5 billion annualized drop in personal taxes.

The job market remains a major support for consumers. Labor Department figures showed filings for unemployment benefits fell to 210,000 last week, the fewest since 1969. Even with steady hiring and low firings, there’s little sign yet of a sustained acceleration in worker pay, though previous Labor Department figures for January showed the biggest annual increase in average hourly earnings since 2009.

The manufacturing report from the Institute for Supply Management indicated sustained strength in the sector as demand remains solid. The group’s factory index climbed to 60.8, more than projected, from 59.1 in prior month. Readings above 50 indicate expansion.

‘Good’ Demand

“Fundamental demand is still really good,” said Timothy Fiore, chairman of the ISM factory-survey committee. “We also saw a big increase in employment, which bodes well.”

Inflation has mostly missed the central bank’s 2 percent target since 2012, though policy makers expect it to rise toward their goal. The Fed’s preferred price gauge -- tied to consumption -- rose 0.4 percent in January from the previous month and was up 1.7 percent from a year earlier, according to the Commerce Department.

The core index, which Fed officials see as a better indicator of underlying price pressures because it excludes often-volatile costs for food and fuel, was up 0.3 percent in January -- the most in a year -- and 1.5 percent from January 2017, the same annual gain as the prior three months.

While households will benefit from lower taxes, most economists reckon consumption in the first quarter is unlikely to match the 3.8 percent annualized pace of the prior period. The Commerce Department data showed nominal consumer spending grew 0.2 percent in January, matching the median forecast in a Bloomberg survey, and following a 0.4 percent gain. Adjusted for inflation, personal spending declined 0.1 percent from the prior month.

“We just need to take a deep breath,” said Omair Sharif, senior U.S. economist at Societe Generale in New York. “Things are still chugging along at a steady pace. Things are just coming down to earth.”

Economists expect that some people may also put the extra cash from lower taxes toward paying down debt or sock it away for a rainy day. In January, the reduction in taxes helped boost the saving rate to 3.2 percent, the highest since August. December’s 2.5 percent rate was the lowest since 2007.

Weaker purchases of automobiles contributed to the slowdown in January outlays as demand cooled following a post-hurricane surge, and the sector remains a possible drag on spending. General Motors Co. and Fiat Chrysler Automobiles NV on Thursday reported hefty sales declines for their big trucks, a troubling sign for a lucrative segment that had been holding up well as the broader U.S. auto market shrinks.

Overall, nominal incomes rose 0.4 percent in January from the prior month, as wages and salaries increased 0.5 percent.

“We continue to expect solid rates of private consumption throughout 2018 as the effects of the tax plan gradually phase in,” Michael Gapen, chief U.S. economist at Barclays Plc, said in a note.

--With assistance from Sophie Caronello

To contact the reporters on this story: Shobhana Chandra in Washington at schandra1@bloomberg.net, Katia Dmitrieva in Washington at edmitrieva1@bloomberg.net.

To contact the editors responsible for this story: Scott Lanman at slanman@bloomberg.net, Vince Golle

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