admin | October 5, 2018
This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.
The U.S. consumer has been on fire since a slow start to the year. Examining the main drivers of consumer spending affirms the robust underpinnings for the household sector and suggests that the consumer should continue to post strong gains for the foreseeable future.
Consumer Spending Is on a Roll
The consumer stumbled out of the gate at the beginning of the year, as households took a brief breather after a stellar Christmas season and were stymied by difficult winter weather. In real terms, consumer outlays fell in January and in February. Since then, the consumer has been on fire. Household expenditures in real terms increased by 0.6% in March and by 0.3% in each of the next four months before finally moderating to a more pedestrian 0.2% rise in August. Over the past six months, real consumer spending has risen at a sizzling 4.2% annualized pace, the fastest clip in almost four years.
Three factors often cited to explain consumer behavior are all unusually robust currently.
Driver #1: Income Growth
The most important determinant of consumer spending at any given point in time, not surprisingly, is income growth. In the current environment, robust labor demand is generating a rapid pace of job gains, longer workweeks, and accelerating hourly wages. Real disposable income, which has exhibited volatility in recent years due to tax changes and gyrations in energy prices, has settled into a roughly 3% trend, almost identical to the gains recorded in spending over the past several years, as shown in Exhibit 1.
Exhibit 1: Year-over-year growth in real disposable income and consumer spending
Driver #2: Household Balance Sheets
Economists also cite the “wealth effect” as a driver of consumer spending. Traditionally, when households’ net worth increases, they upgrade their planned track of lifetime expenditures, spending a few pennies of each dollar up front and preserving a larger cache of assets for later. The most recent quarterly data from the Federal Reserve on household balance sheets was extraordinary.
Household net worth jumped by a whopping $2.2 trillion in the second quarter to a record $106.9 trillion. Even as a ratio of disposable income, net worth has surged to an all-time high, exceeding the equity bubble of 2000 and the housing bubble of the mid-2000s (Exhibit 2).
Exhibit 2: Ratio of net worth to disposable income
Source: Federal Reserve
However, in contrast to those two prior periods, when households attempted to leverage their wealth gains by stepping up borrowing, consumers have been relatively restrained so far in this cycle. Household debt as a percentage of GDP continues to fall and reached a 16-year low in the second quarter (Exhibit 3).
Exhibit 3: Household debt as a percentage of GDP
Source: BEA, Federal Reserve
As discussed in a recent piece, animal spirits are high among households. The Conference Board measure of confidence and the Bloomberg index of consumer comfort both established new highs going back to 2000 in September. Household optimism bodes well for a strong 2018 Christmas retail season.
In sum, the underpinnings for the consumer suggest that spending will continue to post healthy gains for the foreseeable future.
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