Why growing optimism towards the US consumer may be misplaced

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  • Tax cuts, booming labour market conditions and elevated levels of consumer confidence all point to stronger US household spending in the years ahead.
  • Many economists expect this to lift economic growth and inflationary pressures.
  • Westpac Bank says optimism towards the US consumer may be getting a little ahead of itself.

Optimism towards the US economy is growing, especially on the outlook for household spending.

The US labour market is generating hundreds of thousands of jobs each and every month, unemployment is incredibly low, personal tax cuts have just been delivered, household leverage remains low and consumer sentiment is soaring no matter which survey you look at.

Here, look:

Source: Westpac Bank

On the surface, it appears like the perfect mix to bolster household spending, and with it economic growth.

Economists certainly think so, revising up their forecasts for GDP growth and inflation in the next couple of years, along with their expectations for rate hikes from the US Federal Reserve.

After years of stuttering along, the consumer appears set to boost the US economy.

But is the optimism towards an acceleration in household spending misplaced?

Recent US retail sales data hasn’t exactly shot the lights out, falling in each of the past three months, albeit after stronger performances in the latter parts of last year.

You have to go back to early 2015 to find a similarly weak performance.

While lousy weather undoubtedly contributed to the result, an outcome that will likely improve as the weather warms up, it does create some doubt as to whether a household-led economic acceleration will arrive in the years ahead.

Elliot Clarke, economist at Westpac Bank, is one who has some doubts, noting that while spending levels will likely improve in 2018, it’s unlikely to be to the degree expected by more optimistic forecasters.

“While we anticipate services spending will continue at the same pace as the prior two years, and non-durables spending to also be broadly in line, growth in durables spending, particularly auto purchases, is likely to be more subdued,” he says.

Clarke says while recent personal income taxes will help to underpin spending, real worker earnings, adjusted for inflation, are currently flat, sitting well below the levels seen in prior years.

“Growth in per capita real disposable income remains weak versus history,” he says, pointing to the chart below.

Source: Westpac Bank

“More broadly on wages, hourly and weekly earnings as per the payrolls survey are only keeping pace with inflation.”

And with real wage growth running flat, Clarke says declining levels of household savings means there’s little households can do to lift spending levels unless they’re prepared to borrow to do so.

“The savings rate has been at or near its historic low since the end of 2016,” Clarke says.

“And we know from the skew of financial asset ownership towards the wealthy that accrued wealth and capital gains are not something that the ‘median’ household has a lot of.

“Based on the household debt to income trend and declining home equity loan balances, consumers remain unwilling to borrow against their property to fund consumption.”

Source: Westpac Bank

So there’s little savings to divert to spending, real wage growth remains flat and households, at least for the moment, appear unwilling to borrow to spend.

And there’s the risk of higher interest rates, potentially creating headwinds for consumption as household borrowing costs increase.

Clarke says US interest rates are likely to rise even further in the year ahead, forecasting that benchmark 10-year US Treasury yields will hit 3.5% by March next year, up from around 2.8% at present.

“Up until late 2017, term interest rates in the US remained at historically low levels. This supported purchases of housing and auto sales,” he says.

Given his view that rates will increase further, Clarke says that “there is a clear risk that borrowing to purchase will become too expensive for many households”.

Given the headwinds for the consumer, even with the positives they’re currently enjoying from strong labour market conditions and tax cuts, Clarke isn’t expecting the optimism in recent consumer confidence readings to be replicated in hard data on spending, unless there’s an unlikely sharp pick-up in wage pressures.

“While the consumer has received a windfall from tax cuts, this is unlikely to be enough to drive consumption equal to or in excess of that seen in recent years,” he says.

“A marked acceleration in real wage growth would change this situation materially. But in its absence, the US consumer is likely to disappoint through 2018 and beyond.”