Why this week’s releases are critical for your ETF investments

Part 3
Why this week’s releases are critical for your ETF investments (Part 3 of 8)

Will consumer spending affect the yield curve and Fed funds rate?

Consumer spending

The Bureau of Economic Analysis will release its personal income and outlays report for March on Thursday, May 1. The report measures individuals’ income and expenditure levels. Individuals’ personal income includes wages and salaries, rental income, dividends from stocks—like S&P 500 Index (IVV) stocks, and interest income—like income from municipal bonds (MUB). The outlays or the personal expenditure component include how much consumers have spent on goods and services, transfer payments, and interest payments on debt that’s not housing-related. This report also provides estimates for personal consumption expenditures (or PCE). The Fed’s favored measure of annual inflation is the change in PCE.

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Highlights from February’s report

  • Personal income increased 0.3% month-on-month to $47.7 billion in February 2014. This was ahead of consensus estimates of 0.2%. This represented an annual increase of 3.1%.
  • Personal consumption expenditures (or PCE) increased 0.3% month-o-month to $30.8 billion. This represented an annual increase of 3.0%.
  • The PCE price index, or headline inflation, increased 0.1% and 0.9% month-on-month and year-on-year, respectively.
  • The Core PCE price index, or headline inflation excluding the volatile components of food and energy, increased 0.1% and 1.1% month-on-month and year-on-year, respectively.

Investor implications

As consumption makes up over two-thirds of the economy, the report has important implications for GDP growth. An increase in income levels and consumption will increase the GDP. Disposable income levels, particularly, will determine discretionary consumption expenditures. ETFs that invest in the discretionary consumer space include the State Street SPDR S&P Retail ETF (XRT), which tracks the S&P Retail Select Industry Index (an equal-weighted market cap index), composed of the retail sub-industry portion of the S&P TMI. The top ten holdings in XRT include national retailer Sears Holding Corporation (SHLD).

Implications for fixed income investors

The personal income and outlays report has important implications for fixed income investors as well. The Fed uses the annual change in the PCE price index as its favored measure of inflation. The Fed has also indicated that it will likely keep the Fed funds rate low until inflation approaches the Fed’s long-term target of about 2%. The base rate has been in the range of 0% to 0.25% since December 2008. So markets eagerly anticipate the timing of the base rate increase. If the change in the PCE price index moves towards this target, the Fed is likely to increase rates sooner rather than later. This will also likely impact yields across all maturities on the yield curve.

Investors can benefit from rising rates by investing in floating-rate ETFs like the iShares Floating Rate Bond ETF (FLOT). Floating-rate ETFs invest in securities whose interest rates reset at periodic intervals, depending on the prevailing market rate. So investors can benefit from future rate increases.

In the next part of this series, we’ll preview two key manufacturing reports that will be released on Thursday, May 1: the Institute of Supply Management’s purchasing managers’ index and Markit Intelligence’s purchasing managers’ index, both for April.

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