What Recession? Consumers Are Spending, Raising Outlook

Despite all the handwringing, the U.S. consumer is spending and as a result, growth in the third quarter is looking a bit better than economists had been expecting.

September's retail sales

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retail sales

came in at a surprising 1.1 percent gain — better than the 0.7 percent expected — and the best showing in 11 months. There were also revisions to July and August sales, with August now showing a 0.3 percent gain from a previous unchanged.

The gains were broad based, with a 3.6 percent gain in motor vehicle sales, a 1.2 percent gain in gasoline sales and 1.3 percent gain in apparel sales. Without autos and gasoline, the September gain was 0.5 percent.

Several economists are raising third quarter growth forecasts as a result.

"The fear of recessionrecedes when you see a retail sales report like this," said Credit Suisse economist Jonathan Basile.

September's retail sales

Basile said he was raising his forecast for third quarter growth to 2.9 percent, from a prior 2.5 percent. Better than expected trade data added 0.1 percent to the estimate, with the improved retail sales providing the balance. Basile is leaving his 1.9 percent GDP for the fourth quarter unchanged.

But at the same time, Friday's Thomson Reuters/University of Michigan preliminary consumer sentiment reading of 57.5 this month, from September's 59.4, was a dismal reminder that consumers are worried about jobs and their futures. The gauge of consumer expectations fell to 47 — its lowest level since 1980.

"When there's been a decline of 20 percent or more in any given quarter in consumer expectations, retail sales most of the time grow at a slower pace in the following quarter," said Basile.

That could make for a weak holiday shopping season, now expected to be up between about 2.5 to 3 percent.

But experts said it may also be a time to watch what the consumers do more than what they say.

"Not that the economy is particularly robust, but remember where we were two months ago. Everybody was assuming these twin confidence shocks were a harbinger of recession...Not only are we not having a recession but would get close to a 3 percent GDP number in the third quarter," said Barry Knapp, head of U.S. equities portfolio strategy at Barclays.

He said Barclays economists raised third quarter GDP to 2.5 percent from 2 percent.

The slow progress in the European debtcrisis and the debt ceiling debate in Washington torpedoed confidence during the summer, and there are still lingering doubts about leadership and fears the economy could slip back into recession.

J.P. Morgan economist Michael Feroli raised his third quarter forecast to GDP growth of 2.5 percent. He had slashed it to 1.5 percent in August.

"Third quarter economic activity data has shown surprising resilience over the past two weeks, and GDP last quarter now looks like it may come in around 2.5 percent, close to trend growth and the best performance since the same quarter last year," Feroli wrote.

"This morning's retail sales report—with its large upward revision to August spending—leaves consumer spending tracking about a 2.0 percent annualized increase last quarter, a sub-par outcome but much better than what the sentiment indicators would suggest," according to Feroli.

But still, the spending report is a positive in what's been a long slog of negatives. Pimco strategist Tony Crescenzi wrote that the retail report is enough to debunk the idea that consumers aren't spending, making a recession less likely. Core retail sales, without gasoline and autos, increased 5.3 percent year over year, above the long term average, he notes.

"Economic data justify the move away from the high level of recession odds that were being built into market prices," he wrote. "But there remain policy uncertainties great enough to prevent a full recovery from the market accident policymakers caused in the summer months as well as a not insignificant risk that policymakers will further disappoint market expectations, leaving the markets in a quasi state of purgatory."

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