In 2021, the consumption boom was fueled by tax transfers received during the pandemic and the rebound in job creation. Now, these transfers have dried up and disposable income is once again moving in line with its pre-Covid trend. The amount of expenditure remains much more dynamic, boosted by the rise in prices. To date, households have not adjusted their volume of expenditure to the shock on their purchasing power but have compensated by drawing down their credit cards. Even if their financial situation is sound overall, there is a risk of fragility if the phenomenon were to continue.
Focus US by Bruno Cavalier, Chief Economist and Fabien Bossy, Economist
The focus of the week
Prominent among the many counterintuitive results of the pandemic is the strength of consumption. In the goods segment, there was even a real boom to the detriment of spending on services. In the spring of 2020, due to confinement, spending had certainly fallen suddenly, but then it rose sharply, returning to its pre-crisis trend from the start of 2021, then exceeding it in H2 2021 (graph). Since February 2020, disposable income has increased by 5% per year, compared to an average of 4% during the expansion phase from 2011 to 2019. Following the Covid shock, labor income fell in 2020 but was more than offset by tax transfers. During 2021, these transfers have ceased for the most part while the rise in employment and wages takes over. In Q1 2022, the household situation appears healthy. Indebtedness is moderate. The financial savings rate, net of real estate investment expenditure, stands at 4.2% of disposable income. In 2000 and 2007, on the eve of recessions, this rate was close to zero.
However, this situation masks a less favorable short-term dynamic. With the disappearance of pandemic transfers, disposable income is now determined by labor market conditions (hours worked X hourly wage rate). In Q1 2022, it rose by 1.2% q/q, with consumer spending increasing by 2.4% q/q due to a strong price effect. The gap corresponds to a drop in the savings rate of more than one point. Even if households have large excess savings accumulated during the pandemic, this does not offer an unlimited reserve and moreover, its distribution is very unequal by income level. For households subject to liquidity constraints, the solution is increased recourse to credit. Outstanding revolving credit has accelerated very sharply since the beginning of the year (graph). At the aggregate level, default rates are low but there are growing repayment difficulties for the most vulnerable households (1). In a context of rising prices and rising rates, these tensions can only increase and weaken spending.
In May, the first publications on the business climate were negative. In the manufacturing sector, the New York Fed index fell from 60.2 to 51.8 points in ISM-equivalent, erasing the curious rebound of the previous month. The Philadelphia Fed index fell more modestly from 59.3 to 56.5pts, but future conditions fell for the fourth month in a row, to the lowest since 2008. In residential real estate, the NAHB index of builder morale rose fell sharply, losing 8 points, more than the cumulative drop of the previous 4 months. This weakening follows the sharp rise in mortgage rates. However, the absolute level of the index remains high. At this stage, the signal points to a slowdown in construction activity, not a halt and even less a contraction.
In May, according to the preliminary survey by the University of Michigan, consumer confidence fell again (-6.1 pts, after +5.8) to register a new low point in this cycle. The upturn in the previous month was only short-lived, no doubt because prices at the pump, which had begun to decline between mid-March and mid-April, have since rebounded strongly. Now, almost every day, they set a new historic record, while the driving season has only just begun and refining capacities appear to be insufficient. Despite household pessimism, retail sales grew at a sustained pace of +0.9% in April, although weaker than in Q1 2022 (+1.9% per month). The ebb of the Omicron wave supports spending in chain stores and restaurants. According to Atlanta Fed estimates, real consumption (adjusted for the price effect) is expected to rise by 4.8% q/q annualized in Q2 2022.
The other “hard” data also point to a rebound in real GDP in Q2. Industrial production rose 1.1% m/m in April. Business is up in all branches, particularly the automotive industry. Automotive production was almost halved in Q2 2020 due to the lockdown. At the end of 2021, it was at 7% of its pre-Covid level, then at 3% in March; it has just passed over in April. The capacity utilization rate in industry is at its highest since H2 2018. In residential construction, housing starts were virtually stable in April. All in all, the GDPnow index, a proxy for real GDP growth, came out at +2.4% q/q annualized in Q2 2022.
New jobless claims remain low but are rising. The four-week moving average is at 200K on May 14, a three-month high.
Monetary and fiscal policy
In an interview with the Wall Street Journal on May 17, the Fed Chairman drove home the Fed’s intentions. In the short term, the objective is to bring rates back into the neutral zone, namely between 2% and 3%, which requires at least 50bp increases during the next two meetings. Jerome Powell has not ruled out having to raise rates into restrictive territory (>3%) if inflation does not moderate. The Fed’s central scenario is that the economy can avoid a severe recession despite monetary tightening, but painful adjustments are to be expected, for example a rise in the unemployment rate. Nothing in Powell’s words suggests that the Fed is ready to stall due to the market correction (stock indices corrected sharply again on May 18 following various profit warnings in the retail sector ). We can even assume that the recent collapse of various values in the cryptocurrency universe is viewed favorably by the central bank.
To be continued this week
The PMI surveys (and 24) will provide a more comprehensive view of the business climate following the shock to purchasing power and the tightening of borrowing rates. In this regard, the report on household income and expenditure (and 27) will give the inflation estimate based on the consumption deflator (PCE). This measure, which the Fed deems more reliable than the CPI, is expected at 6.3% over one year vs. 6.6% in March. Core inflation should slow from 5.2% to 4.9%. The weight of housing services is lower in the PCE than in the CPI and the estimate of the prices of air tickets and medical services is based on other sources. That said, given the very high level of inflation, regardless of the index used, it is doubtful that the Fed attaches much importance to small deviations resulting from differences in the calculation methodology.
The minutes of the May 4 FOMC meeting (and 25) should not bring great precision to what we already know. The FOMC agreed to deliver the message of a 50bp rate hike in June, then again in July. What happens next will depend on how the economy reacts.