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Consumer Spending Wobbles

December 10, 2012
The Wall Street Journal
BEN CASSELMAN

"It was a dramatic drop," said Jacob Oubina, senior U.S. economist for RBC Capital Markets. "The consumer's not all of a sudden going to pick up the baton."

Consumer spending, which accounts for more than two-thirds of economic output, is especially important at a time when other sectors have been struggling.

Manufacturing, which helped drive the early stages of the recovery, has faltered amid uncertain demand at home and weakness overseas; the factory sector contracted in November after two months of growth, the Institute for Supply Management reported a week ago.

Business investment fell sharply in the third quarter and has likely stayed weak as concerns mounted over the fiscal standoff in Washington. The housing market has shown strong growth this year, but construction activity remains depressed compared with before the recession.

Friday's employment report showed the economy added jobs at a steady though hardly spectacular pace in November, but the Labor Department also revised downward its estimate for the number of jobs added in September and October by a combined 49,000 jobs.

Still, the consumer economy is hardly in free-fall. Retailers reported strong Black Friday sales after Thanksgiving, although subsequent indicators of holiday shopping have been mixed. Auto sales have been robust, posting their strongest mark in nearly five years in November, likely helped by the effects of superstorm Sandy.

Lower oil prices also have pushed down prices at the pump. Inflation has remained in check.

And perhaps most important, home prices are finally rising in much of the country. That is making it easier for owners to borrow against the value of their homes and for some formerly "underwater" borrowers to take advantage of low interest rates by refinancing their mortgages to reduce their monthly payments. Higher home prices can also have a psychological impact, making owners feel wealthier and therefore more likely to spend.

At least some of the recent weakness in spending may have been due to the temporary impact of Sandy, which forced businesses to close and kept shoppers at home across much of the East Coast in late October and early November.

But even after taking Sandy into account, October data were disappointing. Retail sales and consumer spending both fell. Personal income would have risen without Sandy, but barely, the Commerce Department said.

Going over the fiscal cliff would mean, in addition to cuts in government spending in the new year, thousands of dollars in additional taxes for middle-income households and even more for wealthier families.

As recently as September, about half of consumers were largely ignoring the issue, according to a regular survey by RBC Capital Markets. But in the most recent survey, completed last week, 71% of respondents said they were following the cliff debate, and more than half said the threat had hurt their confidence or led them to hold back on spending.

Will Churchill is already seeing the issue affect his business. Mr. Churchill, co-owner of Frank Kent Motor Co. in Fort Worth, Texas, saw strong sales growth at his Cadillac and Honda dealership until early November.

But sales started to slow after Election Day, with many customers attributing their caution to the Washington budget debate. "Fifty percent of the customers we talk to, it comes up at some point," he said. "They're in the market, they want to buy, but the hesitation is that they don't know what's going to be the result in Washington."

Mr. Churchill says that no matter how Washington resolves the fiscal debate, he is optimistic that sales will rebound once the issue is in the past.

But some economists warn that consumer spending could fall sharply if Congress allows the tax increases to go forward.

"Households are going to be in for a rude awakening if we go over the cliff," said Joe LaVorgna, chief U.S. economist for Deutsche Bank DBK.XE -1.45% .

Mr. LaVorgna noted that in recent months, consumers have remained reasonably confident, while businesses have become increasingly pessimistic about the state of the economy.

But that split can't last for long, he said: Either consumers' confidence will lead to spending, boosting businesses' outlook, or else businesses' concerns will lead to job and spending cuts, hurting household balance sheets.

The resolution of the budget debate may well determine the outcome. Slow but steady job growth and the recent rebound in the housing market have left many households on firmer financial footing, and consumers could again drive the recovery if leaders in Washington succeed in averting the cliff's worst impacts.

If they don't, experts including Federal Reserve Chairman Ben Bernanke and the Congressional Budget Office predict another recession.

Grocery store giant Kroger Co. KR -0.15% has seen both consumers' improving confidence and their continued caution.

The Cincinnati-based company last month reported strong earnings and raised its forecast for the year. In a conference call with investors, chairman and CEO Dave Dillon said strong sales of higher-end wines, meats and cheeses were "an indication of people having a little bit more money in their pocket, or at least the willingness to buy a little bit more."

But Mr. Dillon said that the recovery remains uneven, with lower-income shoppers still struggling.

"We think that their situation is still quite difficult, and I'm not actually sure that we've seen improvement there," Mr. Dillon said. The consumer recovery as a whole remains "fragile," he added, "which is why I think the fiscal cliff causes people some heartburn."

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