Following a summer splurge, US consumer spending is slowing dramatically. Richard Berner, a Managing Director and Co-Head of Global Economics at US investment bank Morgan Stanley, estimates that real growth in consumer spending will slow to under 2% annualised in Q4 2009, following a temporary boost to nearly 3.5% in Q3. Berner says it's widely understood that the use-it-or-lose-it ‘cash-for-clunkers' car purchase incentives that began late in July and ended on September 1 fueled more than 40% of that spending gain. With consumer fundamentals still under pressure, therefore, many investors regard September's 0.6% decline in real consumer spending as the start of renewed retrenchment. MS disagrees. Consistent with its long-standing view, slow growth, not no growth, is likely.
The MS economist says tailwinds are starting to offset still-significant headwinds, and MS continues to forecast modest (2%) spending growth over the next several months.
Three key consumer tailwinds are poised to strengthen in coming months: The first: Real, after-tax ‘core' income - - income from wages and salaries, the critical driver for consumer spending - - is likely to rise modestly in the coming months. Although wage gains won't likely improve much until later in 2010, a rising workweek and slower declines in payroll employment finally seem likely to pull core wage and salary income out of its two-year tailspin.
Berner says the evidence for such improvement is so far fragmentary, but timely and forward-looking data suggest that it may be for real. For example, initial and continued claims for unemployment insurance benefits have declined steadily since peaking in June, and the decline in the latter over the last four weeks accelerated to 315,000; that's the fastest pace since an atypical July surge in motor vehicle output reduced continued claims.
The employment components of the two Institute of Supply Management (ISM) indices and stability in the private job openings rate over the past three months seem consistent with smaller declines in payrolls. Surveys of hiring and hiring plans such as those from the MS Business Conditions Survey (the MSBCI) in early October improved noticeably. The hiring series, which tracks the number of analysts whose firms have employed more workers over the previous three months, nearly doubled in October to 17% - - a 13-month high. Moreover, the hiring plans series, which captures the number of respondents whose companies intend to expand payrolls over the next three months, rose an additional three percentage points to a similar 17%. As in the hiring series, this value was the highest mark for this indicator since the intensification of the recession last fall.
The economist says after-tax income also is likely to get a boost from a final installment of tax cuts and rebates early next year. He says that while many observers believe that fiscal stimulus has peaked, they ignore the fact that some of the tax cuts from the stimulus plan don't hit consumer spendable income until the spring of 2010. That's because the ‘making work pay' tax credit is just that - - a credit - - for which consumers got a downpayment with the reduction in withholding rates on April 1, 2009. MS expects a 10% rise in tax refunds in the 2010 refund season that will begin in February, accruing to those who did not adjust withholdings for the 2009 tax year. That increase will offset the modest 3% gain that is expected in taxes withheld on income received early in 2010, and would leave overall individual income taxes essentially flat. As a result, real after-tax wage and salary income may grow at a 4.5% annual rate over the first half of 2010.
Tailwinds 2 and 3: Berner says a second, more modest tailwind comes from the rise in equity values, plus debt paydowns and writedowns, which have ended the slide in household net worth. Household and non-profit equity holdings have retraced about a third of their $11 trillion plunge over the 18 months ended in March. In addition, gross housing wealth has declined by $3.9 trillion since early in 2007, and there is so far no sign of an upturn. He says without question, households will be adjusting to this breathtaking decline in wealth for some time. But the recent upturn in asset values means that the pressure on balance sheets is abating. And consumer deleveraging is also helping balance sheets and discretionary income: The $270 billion decline in consumer and residential mortgage debt over the past year has reduced debt in relation to income by 7%. Combined with lower interest rates, that decline has trimmed the household debt service ratio by about 0.90% over the past two years, which has added around $100 billion to consumer discretionary spending power. Finally, lenders seem to be easing their lending standards slightly as the rise in delinquencies slows and both funding and ABS (asset back securities) markets have improved. Evidence for that improvement may come in the Fed's November Senior Loan Officer survey, likely to be released on November 9th.
Headwinds still linger: "We hasten to add that consumer headwinds remain strong," Richard Berner says. Past weak income and job performance has kept consumers cautious. Real ‘core' income declined by 2.3% over the past year, the steepest rate since Q3 1980, while hours worked have declined by 7%, a record yearly decline. The same applies to household assets and as noted above; the shock to wealth over the past two years will foster a long period of adjustment to patterns of consumer spending and saving. And while deleveraging has trimmed household debt service, some of the decline in debt is clearly involuntary, as it is the product of defaults and foreclosures. Over time the economist says that this tough aspect of cleaning up balance sheets will produce healthier, more resilient consumers, but while it is underway, it leaves them reluctant to spend.
Saving rate decline a poor guide to consumer behavior: Berner says some observers view September's rise in the personal saving rate to 3.3% as an indication that renewed retrenchment is underway. Likewise, they believe that the sharp decline from 5.9% in May to 2.8% in August signals that consumers have exhausted their resources. He says short-term movements in the saving rate are a poor guide to consumer behavior. While the rise in the saving rate from 1% early in 2008 to just over 3% recently reflects consumers' response to falling next worth, most of the movements in 2009 reflect lumpy tax refunds, policy changes and plunging property income. The saving rate began the year at 4.4% and then jumped to 5.9% as consumers received extra tax rebates, transfers, tax cuts and one-time OASDI (old age, survivors, and disability insurance) payments. It fell again as the one-time payments vanished. Declines in interest and dividend income, amounting to $217 billion, accounted for 92% of the decline in overall personal income, and for as much as 1.80% (more than all) of the decline in the saving rate, as such income tends to be saved rather than spent. Smoothing the rate for those changes since 2008 suggests that a sea change in consumer behavior is underway - - one that will take the savings rate to 7-10% over the next several years.
Three key risks to this modest consumer spending growth scenario: First, hours worked and core income could be either stronger or weaker than is expected, accentuating the payback from the summer splurge. MS believes that payrolls might turn positive in Q1 2010 - - perhaps in January or February. But Richard Berner says there are two risks to this view from a policy perspective, one positive and one negative. The mooted employment tax credit that is now being drafted could be a plus (if enacted quickly). But the uncertainty around healthcare reform could well be a minus, especially if would-be employers who do not currently offer healthcare benefits to their employees are required to choose between introducing a plan and paying a hefty tax. Why hire until the dust settles on those proposals? Employers needing more labour input could respond by boosting the workweek and avoiding hires (that will probably happen over the next couple of months anyway). Berner says while the press has highlighted this risk for small businesses, it actually applies to any business that does not currently offer healthcare benefits, including many in services industries.
Second, rising energy quotes, especially for gasoline, could add to the near-term downside squeeze on real disposable or discretionary income. Reflecting the renewed global growth and a weaker dollar, crude oil prices have risen roughly $10/bbl over the past month. Wholesale and retail gasoline prices have followed, the latter to US$2.72/gallon (average all grades) in the latest week. If gasoline prices peak at about $2.85, MS estimates that this price rise might drain about $44 billion, or 0.4%, from disposable income between September and December.
Finally, renewed mortgage foreclosures and home price declines may again pressure wealth and credit availability. "We are not sure if the famous ‘shadow inventory' of yet-to-be-foreclosed homes is as high as the most pessimistic estimates have it. But even if the number of pending foreclosures is half the size of the pessimistic estimates, they will add to a looming supply overhang of unoccupied houses, and such additions may promote renewed declines in home prices as they come on the market in the spring," Berner concludes.
SEE Finfacts article, July 2009: US economist calls for pre-emptive bubble avoidance in contrast with the Greenspan-Bernanke reactive post-bubble cleanup approach
Dr. Stephen Roach, the longtime chief economist at US investment bank Morgan Stanley and since 2007, chairman of the bank's operations in Asia, has called for pre-emptive bubble avoidance in contrast with the Greenspan-Bernanke reactive post-bubble cleanup approach. He rejects what he terms the ideological excuses of bubble denialists such as the former Fed chairman Alan Greenspan who commented in 2002: "We recognized that, despite our suspicions, it was very difficult to definitively identify a bubble until after the fact," he said. The idea that the collapse of a bubble can be softened by pricking it in advance "is almost surely an illusion," he said.
