Consumer Spending Rebound at a Crossroads
In many ways the consumer is the U.S. economy.
Real consumer spending comprises about 70% of U.S. GDP, so if you can accurately forecast where the consumer is going, you have a pretty good idea the rest of the U.S. economy will follow.
Personal consumption expenditures is a broad measure of consumer spending, including spending categories not included in the monthly retail sales reports like spending on services like health care and education.
This measure of consumption began to recover in May. But differences across spending categories have been stark as consumers have made significant shifts in their normal spending patterns. Think bare supermarket shelves of toilet paper and cleaning supplies. Spending on durables like vehicles and appliances have been unusually strong compared to a normal recession, increasing 10.2% since February, while spending on services have plunged 8.2%. Overall the recovery in consumer spending is still a work in progress as personal consumption expenditures remain 3.4% below February levels.Will Consumer Tailwinds or Headwinds Prevail?
There are several headwinds and tailwinds with the potential to propel consumer spending above the pre-virus level or derail the increasingly at-risk recovery. First let’s look at the tailwinds. The personal saving rate surged to 33.6% in April – easily the highest on records that date back to 1959 – partly because consumers were not able to spend at businesses that were closed during the early stages of the pandemic, while incomes were boosted by unprecedented government support.
While the savings rate has fallen each month since April, it remains elevated at 14.1% in August, giving consumers considerable firepower to continue to increase their spending should virus cases ebb and they feel confident enough about their employment outlook to boost their spending.
On the income side, real disposable personal income, or the money left over for spending and saving after taxes and inflation, peaked at a vigorous 16.5% from a year ago in April. This clearly shows the importance of government transfers as the federal government sought to limit the fallout as the U.S. unemployment rate surged to 14.6%. Disposable income growth slowed to 4.0% from a year ago in August as additional pandemic support from the Federal government has been delayed and some jobless benefits have expired. But until or unless disposable income growth turns negative, income growth remains sufficient to support continued consumer spending gains.
A third important tailwind is pent-up demand whereby consumers’ have either delayed or been unable to make certain purchases. A unique aspect of this deep downturn was the shuttering of nonessential businesses to prevent the spread of the virus. This was especially harmful to the services industry with businesses such as restaurants and salons.
As more businesses in the service sector are allowed to reopen, consumers will increase their spending at restaurants and salons, for example, to satisfy their pent-up demand. Indeed, the ISM Services Index improved to 57.8 in September, pointing to an acceleration in service sector growth. However, the service-sector recovery is expected to be gradual with some consumers’ uncomfortable being in crowds until a vaccine is widely available.
Household savings, income growth, and pent-up demand are still powerful tailwinds for consumption, but those tailwinds are clearly fading over time and the headwinds like decelerating job growth and elevated unemployment are becoming more powerful too. Monthly job gains peaked at nearly 4.8 million in June and have slowed each month since with just 661,000 jobs added in September. The unemployment rate remains elevated at 7.9% in September – more than double the pre-pandemic rate of 3.5%. A continued slowdown in job growth will further slow income growth and hold back consumer confidence gains undermining a robust consumer spending recovery.
Consumer spending is projected to rebound a sizzling 38% annualized rate in the third quarter after plunging 33.2% in the second quarter – the sharpest quarterly decline and increase of consumer spending on record. Consumer spending growth in the fourth quarter is forecast at a much more moderate 4.8% and could slow to just 2.0% in first quarter next year, especially if another Federal stimulus bill is delayed until after the election or early 2021.
To learn more, check out this week’s U.S. Outlook Report.