Will the US economy’s resilience last?

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The US economy has proved incredibly resilient this year, despite a higher cost of living and the Federal Reserve’s (Fed’s) attempt to slow the economy with 525 basis points of interest rate hikes. The key question I’m pondering this month is what explains this resilience, and will it last?

The US economy’s strength lies in consumer spending, which has grown at an average of 2.3% annualised over the past four quarters, roughly in line with its pre-pandemic trend. Contrast this to the eurozone, where real consumer spending has grown at 0.2%, relative to a pre-pandemic trend of 1.6%, and the UK where consumer spending has grown at 0.7%, versus a trend of 2.1%.?

There are a number of reasons why the US consumer has been so willing to keep spending. Some of these may persist for some time, but many will fade in the coming months.

Pent-up savings: US consumers received the most sizeable fiscal boost in the pandemic – literally cheques in the post – and unlike their European counterparts have been willing to spend this money. But by most measures these savings, for anything other than the highest income cohorts, have now been depleted.

Labour market and real incomes: The jobs market has remained strong and the squeeze on real wages has already been easing for a number of months as consumer energy prices began falling back in March. Although most measures of employment intentions suggest the labour market will remain relatively firm, wage growth is starting to ease at the same time as oil prices are pushing back up, so some of this real income boost is likely to fade.

Interest rates and the housing market: Interest rates are not eating into consumer income in the way they did in the past, when a much higher proportion of households were on variable rate mortgages. Now, most households are on 30-year fixed rates, which many secured back in 2020 at rates of around 3%. Unless these individuals move or need to remove equity, their mortgage debt is unaffected by the Fed’s actions.

The marginal buyer, of course, is facing a mortgage rate that is likely to top 7.5% when the latest sell-off in bonds feeds through. This is likely to lead to another dip in transactions and construction. The rising cost of unsecured credit (which accounts for 30% of all consumer debt) will also start to affect spending capacity.?

Fiscal policy: Although the cheques in the post ceased, President Biden is learning that fiscal handouts are easier to give than they are to take away. But the US is running a deficit of more than 7% of GDP, which is neither appropriate nor sustainable when the economy is at full employment. Student loan repayments are recommencing and temporary tax breaks in places like California are also ending. However, while hard to quantify, the JOBS, CHIPS and Inflation Reduction acts are all set to continue supporting activity, and they are perhaps the main reason construction remains strong, despite weakness in housing activity.

Animal spirits: It’s always worth remembering that economics is a social science and that we are forecasting human beings. This is what makes forecasting turns in the cycle and judging the lags in monetary policy so very difficult. Households often don’t react incrementally and rationally to incoming adverse news as our economic models predict, but instead switch quickly and collectively from excess optimism to pessimism. I find myself these days recalling the 2006/07 cycle, when again the consumer was resilient for far longer than anyone expected. We all know how that cycle ended. While a lurch down of the magnitude seen in the financial crisis looks unlikely, I suspect the ‘injustice’ of the pandemic and consumers’ desire to make up for lost time has meant households have been resistant to act pre-emptively in the face of headwinds.

But as savings are depleted, the labour market softens, interest rates bite, and fiscal largesse ends, there will be belt tightening ahead and much weaker US economic activity.??

Ultimately, I am still unconvinced by the ‘Goldilocks’ market narrative of resilient growth and falling inflation, and find bonds more appealing than stocks at today’s valuations.

To explore our Guide to the Markets you can click here.

All data is sourced J.P. Morgan Asset Management as of 27 September 2023.

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