In 2021, the consumption boom was fueled by tax transfers received during the pandemic and the recovery in job creation. Now those transfers have dried up and disposable income is back in line with its pre-Covid trend. The amount of expenditure remains much more dynamic, favored by the price increase. So far, households have not adjusted their spending volume to the purchasing power shock, but have compensated by withdrawing their credit cards. Even if their overall financial situation is sound, there is a risk of fragility if the phenomenon persists.
US focus by Bruno Cavalier, Chief Economist and Fabien Bossy, Economist
The focus of the week
Among the many counter-intuitive outcomes of the pandemic, the strength of consumption ranks first. In the goods sector there was even a veritable boom at the expense of spending on services. In the spring of 2020, spending certainly had suddenly fallen due to the lockdown, but then it rose sharply, returning to its pre-crisis trend from the beginning of 2021 and then exceeding it in the second half of 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. After the Covid shock, labor incomes fell in 2020 but were more than offset by tax transfers. Over the course of 2021, these transfers have largely been phased out as employment and wage growth take over. In the first quarter of 2022, the household situation appears healthy. Debt is moderate. The financial savings rate minus expenses for real estate investments is 4.2% of disposable income. In 2000 and 2007, on the eve of the recession, that rate was close to zero.
However, this situation hides more unfavorable short-term dynamics. With the pandemic transfers gone, disposable income is now determined by labor market conditions (hours worked x hourly wage rate). In the first quarter of 2022, it increased by 1.2% qoq, with consumer spending increasing by 2.4% qoq due to a strong price effect. The gap corresponds to a decrease in the savings rate of more than one point. Even where households have accumulated large excess savings during the pandemic, this does not provide unlimited reserve and, moreover, their distribution by income level is very unequal. For households with liquidity bottlenecks, the solution is to take out more 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 interest rates, these tensions can only fuel and weaken spending.
In May, the first publications on the business climate were negative. In manufacturing, the New York Fed index fell to 51.8 points in ISM equivalents from 60.2, erasing the previous month’s odd recovery. The Philadelphia Fed index fell more modestly to 56.5 points from 59.3, but future conditions fell for the fourth straight month to the lowest level since 2008. In residential real estate, the NAHB index of builder morale fell sharply, falling 8 points. more than the cumulative decline of the previous 4 months. This slowdown 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 standstill, much less a contraction.
According to the preliminary survey by the University of Michigan, consumer confidence fell again in May (-6.1 points, after +5.8) and recorded a new low in this cycle. The upswing in the previous month was short-lived, probably because the prices at the pump, which began to fall between mid-March and mid-April, have since risen sharply again. Now they set a new historic record almost every day, while the driving season has just started and the refining capacity seems to be insufficient. Despite the pessimism of households, retail sales grew sustainably by +0.9% in April, albeit weaker than in the first quarter of 2022 (+1.9% per month). The ebbing of the Omicron wave supports spending in chain stores and restaurants. The Atlanta Fed estimates that real consumption (adjusted for the price effect) will increase at an annualized rate of 4.8% q/q in the second quarter of 2022.
The other “hard” data also point to a real GDP recovery in the second quarter. Industrial production rose 1.1% mom in April. Business is picking up across all industries, especially in the automotive industry. Automobile production was almost halved in the second quarter of 2020 due to the lockdown. It was at 7% of its pre-Covid level at the end of 2021, then 3% in March; it just passed April. Capacity utilization in manufacturing is at the highest level since H2 2018. In residential construction, housing starts were almost flat in April. All in all, the GDPnow index, a proxy for real GDP growth, was +2.4% q/q annualized in the second quarter of 2022.
Jobless claims remain low but rising. The four-week moving average is 200,000 on May 14, a three-month high.
monetary and fiscal policy
In a May 17 interview with the Wall Street Journal, the Fed Chair made the Fed’s intentions clear. In the short term, the goal is to bring rates back into neutral territory, between 2% and 3%, which requires a hike of at least 50 basis points over the next two sessions. Jerome Powell has not ruled out the possibility that interest rates will have to be raised into the restrictive zone (>3%) if inflation does not abate. The Fed’s central scenario is that the economy can avoid a severe recession despite monetary tightening, but expect painful adjustments, such as a rise in the unemployment rate. Nothing in Powell’s words suggests that the Fed is ready to falter on the market correction (stock indexes corrected sharply again on May 18 following multiple profit warnings in the retail sector). We can even assume that the recent collapse of various assets in the cryptocurrency universe will be viewed positively by the central bank.
Continued this week
The PMI surveys (the 24th) will provide a more comprehensive overview of the business climate after the purchasing power shock and the tightening of lending rates. In this context, the Household Income and Expenditure Report (the 27th) gives the inflation estimate based on the consumption deflator (PCE). That metric, which the Fed believes is more reliable than CPI, is expected to come in at 6.3% over the year, versus 6.6% in March. Core inflation should slow to 4.9% from 5.2%. The weight of housing services is lower in the PCE than in the CPI, and the estimation of prices for airline tickets and medical services is based on other sources. However, 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 calculation methodology.
Minutes of the May 4th FOMC meeting (the 25th) should not add great accuracy to what we already know. The FOMC agreed to deliver the message of a 50 basis point rate hike in June and then again in July. What happens next depends on how the economy reacts.
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