Never underestimate the hedonism of the US consumer

Although pundits have repeatedly predicted a slowdown in US consumption during the past year and a half, consumer spending has proved surprisingly resilient: In the first four months of the year, consumption increased 2.4% YoY and contributed 1.3 percentage points (pps) to Q1 GDP growth.

Consumption is the backbone of the US economy. It represents around 70% of the economy, therefore it is the key metric to determine the direction of the economy as a whole. In this short article, we will explain what are our views for consumption for the rest of the year.

There are some elements that point that consumption could be weaker in the coming quarters:

(i) The Federal Reserve began its tightening cycle in March 2022, ending 15 years of low interest rates. With the Fed Funds rate at 5.25-2.5%, a major credit crunch was expected.  One of the first indicators to raise the red flag was delinquency rates. Delinquency rates have risen sharply and for younger cohorts default rates are approaching levels last seen during the global financial crisis. This is the case for both car loans (Figure 1) and credit card loans (Figure 2).

Delinquency rates on car loans have risen sharply

Credit card delinquencies have soared since 2022

Source: New York Fed Consumer Credit Panel/Equifax

This is what an Econ 101 economics course would teach you: when interest rates go up, the economy slows, credit contracts and default rates increase. The impact is higher on low income (mostly the young) and more indebted (30-39) cohorts.

(ii) The second item that pointed to a significant slowdown in consumption was the  is depletion of excess savings: the US government made extraordinary transfers to families during the pandemic creating a large stock of excess savings (the accumulated difference between actual personal savings and the "normal" - trend - savings rate). The excess savings pile reached a peak in mid-2021, it has been steadily declining since. Many analysts have attributed the good performance of consumption to the existence of this pile of money resting in consumers bank accounts. The problem is that, according to estimates from the San Francisco Fed,  by 1Q24 the excess savings had been used up.

Excess savings are depleted

Our preferred metrics

We believe that the excessive focus on both default rates and excess saving is a mistake. It is the proverbial problem of looking at the trees instead of the forest. Our analysis points that there are four key variables that explain most of the behaviour of consumption: households net worth, real incomes, employment and consumer confidence.

Household net worth

Household net worth has a very high correlation with real consumption (see Figure 4), and it makes total sense: when households are and feel wealthier, they tend to save less of their income  and consume more. Both financial assets and real assets (i.e. house prices) are increasing. Net worth is up 10% you in the second quarter. With lower long term rates house prices are expected to continue to rise. The story is less clear but momentum at least favour for a positive look also for financial assets.

Net worth is on the rise in the US

Source: Forvis Mazars EIH, Macrobond

Real incomes

As inflation rose in 2021 and 2022, real incomes fell significantly. Over the past year and a half, however, real incomes have recovered: wages have risen at a pace of 5% while inflation has fallen to ~3%, resulting in real wage growth of ~2%. Real incomes are a strong coincident indicator (and determinant) of consumption, and in our view, given the tightness of the labour market, it is clear that wage growth will exceed inflation in the coming quarters.

Real wages are rising

Employment

Employment growth has been very strong since the end of the COVID mobility restrictions, job gains remain above the historical average and there is still a gap of 1.4 million between vacancies and unemployed.  It is therefore likely that we will see strong employment figures in the coming quarters and unemployment in the low 4% range in the second half of 2024.

Job gains remain well above the historical average

Source: Forvis Mazars EIH, BLS.

Consumer confidence

Consumer confidence surveys tap into people's feelings about the economy and their job security.  When they feel optimistic, they're more likely to believe they have the financial means to spend. This can be a self-fulfilling prophecy – increased spending leads to economic growth, which can reinforce positive consumer sentiment. Surveys often ask about future spending intentions. If consumers are feeling confident, they might be more likely to report they plan to buy a new car or appliance, which can translate to actual consumption in the coming months. We found that the YoY change in consumer confidence has a high correlation with consumption growth (leads real consumption by 1-2 quarters). Moreover, consumer confidence has been improving sharply in the past quarters (see figure).

Consumer confidence is improving

Source: Forvis Mazars EIH

Conclusion

We see consumer spending remaining strong due to continued strong employment gains, rising real wages and positive wealth effects. Strong consumption will boost economic growth, which will likely remain above the long-term trend (2.5%).  A strong economy will also mean sticky inflation and fewer interest rate cuts.

Santiago Rossi, Senior Economist