Lately, there’s been some contradictory data about the state of the economy. While there was a robust holiday spending in November and December, household credit delinquencies have been mounting recently, which translated on somewhat softer retail sales in January.
Looking forward to 2024, the rate of consumer spending is expected to be driven by three key factors. They are: a) a strong labor market, b) interest rates to stay high, and c) net household savings. Let’s look at them individually.
- Labor market:
The labor market has been holding up very well and lately, i.e. ever since Q2 2023, there was a reacceleration in payrolls. This means that real disposable income increased, and we would expect it to remain strong going forward into 2024. We do not expect the disposable income to decrease, even in the event the labor market should soften somehow. Overall, this is an important fact and a direct consequence of it is: If people have jobs, they spend money. - Interest rates:
The Fed started raising interest rates two and half years ago, initially to preventively keep the rate of potential inflation to come in check. Still, lately, it raised interest rates to combat it aggressively. As stipulated multiple times, we would expect the rate of inflation to stay stubbornly high for longer than then expected and consequently interest rates are expected to stay higher for longer too.Technically speaking, since interest rates stay high, the cost of capital will go up and therefore homeowners are expected to pay more for the capital required, which in turn weighs on future discretionary spending. Yet, the good news is that there is a substantial amount of fixed-rate debt, and as a result less sensitivity to debt service obligations.
It is estimated that 90 percent of household debt is locked in at a fixed rate. So, over the last couple of years, we’ve seen little household sensitivity to higher interest rates as the Fed has been raising interest rates. Right now, debt service costs are still below their 2019 levels. One can expect to see a little upward pressure here over the course of this year and hence consumer spending should not be impacted.
- Household savings:
The last thing to look at is the wealth side. Since the start of 2020, there has been a 50 percent accumulation in real estate wealth, and we would expect this trend to continue, though at a much lower pace. On a relative basis, people will therefore be feeling pretty good given that there is no depreciation due to their home equity. This is good news for the consumer sentiment, which in turn will be supportive for consumption.
After all, while US consumer spending might be slightly slower in the year ahead, fundamentals are still looking good.