Manufacturing activity accelerated in October according to the Purchasing Managers surveys, and durables manufacturers’ new orders were strong across categories. But consumer spending growth, which soared in the third quarter, seems to have slowed during the month. This combination of rising production and orders and slowing consumption implies that inventory is beginning to be rebuilt.

Were it not for the fact that mortgage refinancing activity slumped in recent months and that consumer debt is so high, the slowing in consumption could be shrugged off as weather induced pause. This may in fact turn out to be the case, but it makes us cautious because we have been looking for October to mark a peak in demand momentum.

Over the past three years every time interest rates spiked up, mortgage refinancing activity would slump, money growth would slow, and soon thereafter the economy would lose momentum. This was because mortgage refinancing was the only vehicle by which the Federal Reserve’s stimulative monetary policy was being transmitted through the economy. Bank lending was weak because businesses kept scaling back both capital spending and inventory investment decisions.

Perhaps this time the lagged response of consumers to the slump in refinancing activity was merely delayed by the timing of tax cuts and rebates. Indeed, money supply growth has dropped sharply in the last few months, suggesting the overall economy may now be ready to lose some momentum. It will, unless capital spending and inventory investment plans gain traction. An upturn in these will spur lending, boost employment and income, and thus enhance prospects for the long hoped for, but thus far elusive self-sustaining expansion.

To date the evidence is mixed. Capital goods and shipments rose at a double digit rate in the third quarter while non-residential construction stabilized. Industrial materials prices have been strong in recent months as well, perhaps giving producers an incentive to hold goods in anticipation of future price strength. Finally revisions to prior months’ changes in payrolls were heartening and October’s 126K rise was respectable.

But offsetting these is the fact that capacity stabilization rates are very low domestically and worldwide. Fiscal stimulus will be less going forward, and final goods prices excluding food and energy are still falling, as is disinflation in the service sector. Finally, while the past few month’s improvement in the labor market condition is welcome, the improvement is still short of the 150K monthly increase that are needed to absorb the labor force and offset the foregone income from the collapse in mortgage and refinancing.

We would feel better about the economy’s prospects if consumers had completed their balance sheet repair. But the saving rate is still low, debt ratios are awfully high, and current job gains will not yield sufficient income growth to enable consumers to boost both saving and spending.

The economy’s growth rate will very likely remain above trend in this year’s final quarter. The risk is that it fades below trend early next year. And if it does, remember that policy options are limited. The deficit will preclude additional fiscal stimulus, and the Fed has limited room to cut short term rates. The only sane option would be to get long rates back down. Hopefully this option would be quickly exercised so as to preclude our legislature’s exercising the insane option of erecting artificial trade barriers.