The American Consumer: Still Ready to Drive the Recovery

I remember the day when I first appreciated the importance of the American consumer.

It was the winter of 1982 and I was huddled around a table with some fellow econ students in the cavernous restaurant of University College Dublin, gulping down the sinister brew which the authorities labeled as “tea”.? As undergraduate students, we were fed a narrow diet of theory and math.? But the Irish economy was once again floundering helplessly in the heavy wake of an overseas recession and the only relevant question was: when would the American consumer bounce back?? I remember being very impressed when someone at the table started reciting the latest U.S. 10-day car sales numbers and asserting that a recent turn up in these data meant that better times were surely ahead for the global economy.?

So it proved to be, and nine months later I was on a bus heading from Metro Airport to Lansing, Michigan to start grad school and to get a front row seat on the American consumer revival.? The truth is that the American consumer has long been the ignition key for the global economy and still is, although to a lesser extent, today.?

Recently, however, consumer spending has slowed down.? After posting more than 11% annualized growth in the first two quarters of this year, consumption may have grown by as little as 2% in the third, as the Delta variant slowed the services rebound and a chronic shortage of inventories slammed light-vehicle sales.?

However, consumer momentum should improve in the months ahead, driving the economy closer to a full post-pandemic recovery and keeping inflation hot.

This forecast is based on a review of the usual checklist of consumer fundamentals, namely, disposable income, wealth, debt, demographics, and confidence.? But it also depends on an expectation that the drag effect of the pandemic on the economy will ease in the months ahead.

In the last week of September, there is finally some better news on the Delta variant.? New confirmed cases in the last week were just under 120,000 per day, down from a peak of over 160,000 per day at the start of the month.? Hospitalizations, have fallen to 82,000 from a peak of nearly 104,000 in early September.? Fatalities are still running at a terrible pace of over 2,000 per day.? However, given the improvement in other data, these numbers should also begin to retreat in the days ahead.?

By now, we estimate that well over 80% of the American public have some degree of immunity to Covid-19 either through vaccination or infection and vaccines for children aged 5-11 could be approved for use next month.? This could mean that the Delta wave is the last major wave of the disease.? More importantly from an economic perspective, the pandemic is now less of a drag on consumer spending as consumers have largely either decided to get back to normal or figured out how to operate efficiently in a pandemic environment.? Consequently, while the Delta variant has removed some of the momentum from the post-pandemic reopening, we see the virus as having a dwindling impact in slowing consumer spending going forward.

On disposable income, it is important to recognize that the strong gains seen in 2020 and early 2021 are likely to wind down in the months ahead.? On the positive side, wage gains remain robust, with average hourly earnings for production workers now 9.9% higher than two years ago.? Over the next few months, job gains should reaccelerate and, combined with continued strong wage growth, should lead to a strong advance in wage and salary income.

Dividend and interest income should also grow strongly in the months ahead as companies distribute some of their record profit gains and long-term interest rates edge up.? Meanwhile, proprietors’ income should improve as economic reopening continues.

However, government transfer payments will wind down.? Even if Congress passes a reconciliation bill extending enhanced child, dependent care and earned income tax credits, expanded federal unemployment benefits have come to an end, undercutting consumer income.? In addition, if a reconciliation bill is passed in the next few weeks, it will likely contain higher taxes on upper-income individuals in 2022, hurting both consumer spending and flows into investment vehicles.

On net, this could mean growth in real disposable income of just 1% between the third quarter of 2021 and the third quarter of 2022.? However, the personal savings rate should fall back from roughly 9.0% to 6.0% over the same period, allowing spending to rise much more rapidly.

For some, this decline in the savings rate would simply reflect the ability to spend more due to very strong gains in wealth.? In just the last two years, we estimate that the net worth of all American households rose by an astonishing 28.7% or $32.5 trillion, a number that equals 1.4 times annual U.S. GDP.? For richer households, this could fuel strong consumer spending growth even if taxes increase and income growth slows.

For middle-income and poorer households, the last two years have seen a major improvement in financial positions as consumers took advantage of government stimulus checks and lower mortgage rates.? Credit card debt fell from $1.092 trillion in December 2019 to $911 billion by March of this year, leaving consumers with plenty of available credit to ramp up spending as the pandemic winds down.? Meanwhile, homeowners were able to refinance to take advantage of lower mortgage rates with the average effective mortgage rate on existing debt falling from 3.87% in the fourth quarter of 2019 to an estimated 3.40% in the third quarter of 2021.?

Overall, the surge in wealth and improvement in balance sheets should support strong consumer spending growth into 2022, even as disposable income grows more slowly.?

Demographics have, of course, been very weak throughout the pandemic with a terrible death toll, lower immigration and an initial decline in births all contributing to close to zero population growth over the past 18 months.? However, an easing in the pandemic in the months ahead should reduce deaths and allow for an increase in immigration.? Meanwhile, early data from individual states show a surge in births in recent months, as initial fears about the economic impact of the pandemic eased.? Because of this, 2022 should see something of a demographic boost to consumer spending relative to the last two years.

Finally, consumer confidence has fallen sharply in recent months, partly reflecting dashed hopes that the pandemic would end over the summer as well as higher inflation, natural disasters and the chaotic U.S. exit from Afghanistan.? However, we expect confidence to improve in the months ahead, as the pandemic does finally fade.? Confidence, of course, also depends on the ability of Congress to pass an infrastructure bill and a budget for 2022 while raising the debt ceiling and keeping the government open.

In summary, as was the case 40 years ago, there are plenty of reasons to be optimistic about the American consumer and U.S. consumer spending should power the U.S. economy to strong growth, still high inflation and rising interest rates entering 2022, a positive for equity markets but a headwind for fixed income portfolios. ?

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