- Macro Strategist
Switzerland, Institutional
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In 2023, consumer resilience carried the US economy, helping growth stay strong despite recessions in housing and a range of industries, especially on the goods side of the economy. This year, the story is more nuanced. It features slower consumer spending broadly but also a notable divergence between consumers who are thriving (thanks to termed-out mortgage debt, for example) and those who are just surviving (under the increased weight of variable-rate debt like credit cards). The increased stress faced by lower-income consumers, those who rent, and younger cohorts is increasingly visible in corporate results and financial metrics.
These consumer crosswinds have implications for the broad economy and monetary policy, and they suggest greater equity market dispersion in the months ahead. There are also longer-term implications, including for labor market trends (which I’ve written about here) and economic growth.
Key conclusions:
- My base case is that we’ll see slower consumer spending in 2024, driven by normalization of excess savings, smaller income gains, and the easing of pent-up demand in many service categories. Some consumers are being hit harder by higher interest rates (because they have variable-rate rather than fixed-rate debt) and higher inflation (i.e., lower-income households facing higher consumer inflation versus higher-income households benefiting from higher-asset price inflation).
- Consumers could see higher incentives or markdowns in areas like autos, restaurants, and grocery stores, where bloated post-pandemic pricing has yet to normalize. Prices of existing homes and prices in the leisure and hospitality industries are vulnerable too, although supply tightness may limit reductions.
- In areas where price gains have already normalized, the relative winners among consumer companies could be determined by the ability to cut costs and improve efficiency gains, especially as nominal economic growth normalizes.
- The surge in immigration has taken the steam out of wage growth and is creating pockets of demand in the consumer space. The US election outcome bears watching given the enormous policy differences between Trump and Biden on immigration, as well as tariffs.
- Savers have been the relative winners of higher interest rates as they finally earn a yield on their nest eggs. These have tended to be higher-income households, many nearing retirement. This boost in income has driven better spending outcomes for these cohorts.
- The Fed’s attempt to balance its full employment mandate with its efforts to tame inflation matters to consumers and the broader economy. My base case includes measured rate cuts, but the Fed is walking a fine line and the range of possible outcomes is wider than current market consensus suggests, given still-sticky inflation and signs of labor market softening.
A closer look at the near- and long-term consumer outlook
Post-pandemic normalization of spending and savings — Consumer spending on goods surged during the pandemic, followed by spending on services as the economy reopened over the last two years. Both areas of spending have now fallen back to their pre-pandemic trend. Meanwhile, excess savings, a key driver of consumer resilience and spending during the pandemic, has come back to earth, leaving consumer incomes as the primary driver of growth (Figure 1).
Figure 1
Slower income gains and a fraying labor market — I expect slower income gains in 2024 as both employment and wage gains moderate. Real incomes were growing around 2.5% as of March 2024, down from nearly 3.5% nine months ago, and I believe we’ll see some additional slowing in the months ahead.
Companies have adjusted to softer demand by cutting back hours. They have also been laying off some employees, especially in areas that require higher levels of education such as technology and financial services. Overall, corporate and consumer surveys paint a picture of a low hiring rate (back to 2014 levels) and a low quit rate, but, for now, contained layoffs. The services recovery mentioned earlier has helped create the strongest job growth for those at the low end of the income scale. Meanwhile, the unemployment rate has risen for those with advanced degrees while holding steady for those with bachelor’s degrees. Going forward, companies will have to seek additional cost savings or give up some margin as household incomes soften and consumers become more discerning. The risk of a prolonged period of tight Fed policy is that the unemployment rate can rise abruptly if margins erode sufficiently. This recession risk is underpriced in financial markets today.
Finally, as noted, immigration has surged, helping to slow wage growth and reduce upward pressure on inflation.
Fading headline disinflation tailwinds, less discretionary money to spend — Headline inflation has been below core inflation for much of the past year, helping to restore some purchasing power for stretched lower-income consumers. I expect this trend in headline inflation to reverse course in the second half of 2024, adding to pressure on companies to fight for consumer dollars.
Headline inflation has benefited from the steep decline in prices on the goods side, which saw recessions in multiple industries. I think this has run its course. The one exception is in the auto industry, where I expect buyer incentives to continue improving as inventories have largely normalized. On the services side, I think pricing should moderate as consumers become more price conscious and pent-up demand fades. Areas such as restaurants and leisure should see more discounting or incentives to lure spending. The lock-in effect of the Fed’s rate hikes (higher rates make existing homeowners less likely to sell) has kept home inventories low and prices high. Still, I see room for shelter inflation to move somewhat lower over the course of this year.
The dichotomy between variable-rate and fixed-rate debt — While average household debt payments as a share of income are back to 2019 levels, the actual dollar payments made on variable debt (which represents roughly 30% of total consumer debt) are now about the same as the payments made on mortgage debt. This large payment shock is responsible for the recent surge in consumer delinquencies (Figure 2). Strong employment gains have helped consumers keep up broadly, but the percentage of credit card users making only the minimum payment each month is starting to tick higher, in what could be a warning sign. In addition, the one-year grace period for student debt payments expires in October, which could well leave some consumers with yet higher cumulative debt payments.
Figure 2
More early retirements thanks to a return on cash savings not seen for a long time — Taking advantage of higher yields and still-high asset prices, many are retiring “early” relative to the pre-pandemic trend. A study by the Federal Reserve Bank of St. Louis puts this number at over 2 million workers since the pandemic. There may be many more to come: 2024 has been dubbed “peak 65” as roughly 4.1 million Americans turn 65 each year from 2024 through 2027 (about 11,200 each day!). Paradoxically, this early retirement trend could be bringing down savings and pushing up consumption spending by this cohort. Leisure has been a beneficiary.
Many in this age group have been impacted by the Fed’s lock-in effect mentioned earlier. The recent Freddie Mac proposal that would allow the government-sponsored enterprise to purchase certain second mortgages in an effort to “unlock” more home equity could impact spending as well, although its effects may not be felt until 2025.
Final thoughts on policy and inflation — The outcome of this year’s US election could impact tariffs, particularly on Chinese imports, for years to come, potentially driving up prices for consumers and creating more supply chain headaches. The slowdown in wage gains driven by the addition of more immigrants to the labor supply could also be vulnerable if Trump regains power and follows through on his promise to deport 2.5 million undocumented workers who have entered the US since the pandemic.
Meanwhile, the Fed’s dual mandate has left it sensitive to shifts in the employment picture but still keen to get inflation back down to its target. Until it sees greater weakness in the labor market, the Fed will focus on moving core inflation toward that target. This leaves the central bank guiding policy toward eventual rate cuts but without specifying a calendar date (i.e., data, not date, dependent). Again, this remains a difficult balancing act with risks on both sides of the dual mandate.
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Andrew Heiskell
Nicolas Wylenzek