Our panel of analysts discusses the health of the US consumer
through the lens of spending, credit use and home
ownership.
----- Transcript -----
James Egan: Welcome to Thoughts on the
Market. I'm James Egan, Morgan Stanley's co-head of Securitized
Product Strategy, and today we're going to take a look at the
state of the US consumer from several different perspectives.
Recent economic data suggests that the US economy is strong, and
that inflation is on a downward trend. Yet, some of the
underlying performance data is a little bit weaker. To understand
what's happening, I'm joined by my colleagues Arunima Sinha and
Heather Berger from the Global and US Economics teams.
It's Thursday, November 7th, at 10am in New York.
Now, the macro data on the consumer has looked pretty strong.
Arunima, can you give a little bit more detail here? And
specifically, how has consumer spending in the US been trending
relative to where it was last year?
Arunima Sinha: So, a good place to start,
Jim, would be just to see where consumption spending was last
year. And there it ended on a strong note. And in the first
three-quarters of 2023, the average quarterly analyzed growth for
consumption was just under 3 per cent. And that's where we are
this year. We've seen solid growth rates in all three quarters
this year, with the third quarter at 3.7 per cent. A particularly
interesting aspect has been that the spending on goods has
actually accelerated this year, with the third [quarter] number
at a blistering 6.0 per cent on a quarterly basis.
We have chalked this down to labor income growth remaining
robust; and we did an analysis which showed that past growth in
labor income boosts real consumption spending. Over this year,
labor compensation has been growing strongly. So over 6 per cent
in the first quarter and about 3.5 per cent in quarters two and
three.
And so, we continue to expect that that solid labor income growth
is going to continue to boost real consumption spending.
James Egan: All right. So, if I'm hearing
you correctly – good spending, holding up; services, holding up.
What about discretionary versus non-discretionary spend?
Arunima Sinha: That's a great question,
Jim, especially because discretionary spending is 70 per cent of
all nominal personal consumption spending in the US. So just for
context, what does discretionary include? It's going to be all
the spending on durable goods, some non-durables, and then
non-essential services such as health and transport, financial
services, etc. And what we also saw – that a larger share of
labor income is now being spent on discretionary items relative
to the pre-COVID phase.
So where are growth rates running? Discretionary spending is
running strong on both a nominal and a real basis. So, on a
nominal basis, we have about 5.5 to 6 per cent year on year, over
this year, and over 3 per cent on a real basis. And these are
largely in line with pre-COVID rates, if a little bit stronger
now.
For non-discretionary spending – that's the spending on food at
home, and clothing, energy, and housing services – nominal
spending has been decent. So, 4 per cent year on year on the
first three quarters this year, and real spending has been a
little bit less than the pre-COVID rate. So, between 0.5 per cent
to 1 per cent. And so, this suggests what we expected to see,
which is there's likely greater price sensitivity among consumers
for these non-discretionary categories.
What do we see going forward? We think that those increases in
labor income are going to continue to provide boosts to
discretionary spending. And one of the interesting aspects that
we found was that lending standards seem to matter for
discretionary spending. So, there's been some slowing down and
the tightening of lending standards – and that could provide a
further tailwind to discretionary spending.
James Egan: Alright, that all sounds pretty
positive and makes sense as to why we're getting so many
questions about economic data that looks very healthy from a
consumer perspective. But then, Heather. Other consumer data is
showing a little bit more weakness. Arunima just mentioned credit
standards. What are we seeing from the performance perspective on
the consumer credit side?
Heather Berger: Well, as you mentioned, the
consumer credit data has shown more weakness, as more consumers
are missing payments on their loans. We initially saw delinquency
rates start to pick up in loans concentrated towards consumers
with lower credit scores, such as subprime auto loans and
unsecured personal loans, as those consumers were more affected
early on by high inflation and then rising rates.
Delinquency rates for those lower credit score loans are near the
highest we have on record in some cases. In the past year,
though, we have also seen that delinquency rates have picked up
in loans aimed at consumers with higher credit scores, such as
credit cards and prime auto loans. The weakness in these is not
as extreme as in subprime, but the delinquency rates of the loans
taken out recently is still relatively high historically.
James Egan: So, it sounds like what you are
describing is that there are pockets of consumers that are
feeling more weakness than others.
Heather Berger: Yes, exactly. And so, on
the prime consumer side, even if these consumers have higher
credit scores or higher incomes, if they took out loans recently,
they likely did so at higher rates, and they're really feeling
the pressures of higher debt service costs.
We can also see some of the bifurcation between low income and
high-income consumers. In some of the more detailed economic
data, we have a breakdown of 2023 spending by income group, which
is a bit outdated but still useful to see the narrative – and
what it shows is that in 2023 higher income consumers made up
near the largest share of discretionary spending as they have
historically. For lower income consumers, their spending has
shifted more towards essentials, with shelter increasing the most
as a share of their spending from the prior year.
Now, Jim, we really think that the housing backdrop has played a
role here, so can you explain a bit more of what's going on
there?
James Egan: Yes, now my co-head of
Securitized Product Strategy, Jay Bacow, and I have been on this
podcast a few times talking about the role that the housing
market is playing in the economy right now. We've really talked
about the lock in effect. And when we're thinking about the role
that housing plays in the consumer specifically, we're talking
about lower income households, more discretionary spending,
shelter increasing that's not happening at the higher end, and we
think that's the lock in effect.
A majority of homeowners were able to get low fixed rate
mortgages for 30 years with 3 or 4 per cent mortgage rates. The
effective mortgage rate would be on the outstanding market right
now is, average is 4 per cent. Prevailing rates are north of 6
per cent right now. So that has helped that higher end consumer
who is more likely to be a homeowner – 65 per cent of the US
households are homeowners – maintain that lower level.
But I don't want to gloss over that entirely. Other costs of
homeownership are increasing. For instance, property taxes and
insurance costs are up. Homeowners have realized swelling home
equity amounts amid record home price growth in recent years;
perhaps giving them more confidence to spend, but that equity
hasn't exactly been easy to access.
Now, second lean and HELOC balances have been increasing; but the
amount of equity that's being withdrawn falls well shy of
previous highs, which were set back in 2009. And that's despite
the fact that the overall equity in the housing market is $20
trillion larger today than it was back then. While the equity
itself should provide a buffer for homeowning consumers from
ultimately defaulting, these dynamics could be resulting in some
of the short-term delinquency increases that we think we're
seeing in products like Prime Auto, for example.
But Arunima, can you tie a bow on this for us? What does all of
this mean for the consumer moving forward?
Arunima Sinha: Moving forward Jim, we
really just see a solid consumer. So, for the end of this year,
our forecast is real consumption spending growing at 2.6 per
cent; at the end of next year at over 2 per cent. And that really
is tied to our view on the labor market – that it's going to
continue to decelerate, but not in any sudden ways.
So that's it. We are seeing a strong consumer, and we are going
to be watching for pockets of weakness.
James Egan: All right. Arunima, Heather,
thanks for taking the time to talk.
Arunima Sinha: Thanks so much for having me
on, Jim.
Heather Berger: Great talking to you both.
James Egan: And to our listeners, thanks
for listening. If you enjoy Thoughts on the Market, please leave
us a review wherever you listen and share the podcast with a
friend or colleague today.
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