Recently we have witnessed growing concerns around the health of the U.S. consumer. The January 2020 Federal Open Market Committee (FOMC) statement weakened the Federal Reserve’s (Fed’s) assessment of household spending from “strong” to “moderate.” The following day, the Q4 2019 initial GDP report indicated personal consumption growth undershot expectations at 1.8%. After a surprisingly strong year of consumption growth, evidence that the consumer is slowing from the unsustainable pace of 2019 is not unexpected. However, signals from labor markets, household balance sheets and consumer sentiment suggest that room for optimism remains and the consumer can persist as a driver of the economic cycle.
2019 was another strong year for labor markets. Unemployment reached a cycle low of 3.5% and underemployment dropped to the historic low of 6.7% in December 2019. The Atlanta Fed Wage Tracker shows wage growth for 2019 at 3.7%, modestly outpacing inflation, and 2.3 million jobs were added. The current strength of the labor market provides near-term stability for the U.S. consumer while relatively low wage growth insulates employers from a significant margin squeeze. So how much room for growth remains? Looking ahead, the labor force participation rate indicates that momentum in the labor market can continue. Currently, the prime age (25 to 54 years) labor force participation rate sits at 83%. Even after a four-year upward trend, this rate is still below the record high of 84.6% achieved in 1999. While employment growth may slow, the participation rate suggests that growth can be sustained as a strong economy pulls more people into the labor force while increasing wages, especially for those at the lower end of the wage spectrum.
Household balance sheet
Although consumer debt continues to reach historically high balances, the average consumer’s ability to cover debt payments remains at comfortable levels. A household’s financial obligation ratio, the measurement of debt payments as a percentage of disposable income, shows that debt coverage is near its best level in thirty years. Approximately 15% of a household’s disposable income goes toward debt obligations, well below the levels witnessed during the mid-2000s housing bubble. We believe the decline in the financial obligation ratio over the last decade is due to a host of factors such as lower interest rates, more conservative lending and borrowing habits, and lower home ownership rates.
Household financial obligation ratio
Source: Federal Reserve Bank of St. Louis.
This low debt burden has allowed consumers to divert more money into savings and consumption. Consumers currently have the ability to simultaneously spend more and save more without pressure from their debt payments. The proportion of consumption spending excluding food and energy is over 88%, showing that moderate inflation and low gas prices have allowed consumers to spend elsewhere. Savings rates have stabilized around 8% over the past two years. This level of durability in household balance sheets confirms the U.S. consumer’s resilience.
The strong labor market and healthy household balance sheets have led to steady optimism from the U.S. consumer. The Consumer Sentiment Index suggests that consumers are confident in the economy, which typically translates into more spending on big-ticket items. Within the past two years, consumer sentiment has been unaffected by political uncertainty, even as the U.S.-China trade war has dominated headlines. The stability of confidence through these headwinds suggests that the consumer is unlikely to falter even if the economy slows from the current pace.
Despite the current strength of the U.S. consumer, we continuously monitor key areas where cracks could emerge in the future. We think it is important to question how much further unemployment rates can fall. Any weakness in the labor market could have a cascading effect on consumer confidence and ultimately consumption. Even as the consumer has seemed unflappable despite recent political headwinds, we are monitoring risks that show consumer sentiment wavering due to uncertainty related to the 2020 presidential election. Finally, political noise could increase business uncertainty. This could hurt payrolls and ultimately erode the consumer’s strong position.
The expanding labor market, healthy household balance sheets and optimistic sentiment tell us that resiliency from the U.S. consumer can continue to drive the economic cycle. More modest expectations for consumers in 2020 — reflected in the Fed’s January meeting statement and the fourth quarter GDP release — are to be expected following a strong 2019. The U.S. consumer remains on a solid foundation that we believe will continue to support U.S. equities going forward. In our view, labor-market growth, strong household finances and confident consumers will prolong the U.S. economic expansion.
Originally Posted in February 2020 – U.S. Consumers: Confident Amid the Crosswinds
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