Viewpoint
January 19, 2024 | 14:39
January 19, 2024
Economics
Economics
Economics
Economics
Economics
Economics
A Better Start to the Year |
| A soft landing for the economy came into better focus this week with solid December growth heralding a stronger start to 2024. So, we raised our first quarter GDP growth outlook to 1.2% from 0.6%, driven by a consumer and labor market that remain more resilient than expected. We now expect a more gradual cooling in real consumer spending in the first quarter, with the Q1 call at 1.8% annualized, down from an estimated 2.5% in Q4 and 3.1% in Q3. |
| The economy ended the fourth quarter on a high note. December employment, retail sales, and industrial production all beat our forecasts as well as consensus, pushing up our estimate of fourth quarter GDP growth to 1.5% from a previous forecast of 1.0%. Growth would even be better (around 2.5%) if it weren’t for a large drag from business inventory investment that should subtract almost 1 ppt from GDP growth when the advance numbers are released next Thursday. But the strength is not only from the consumer: a resurgence of homebuilding (on falling mortgage rates) and continued growth in business fixed investment should be important elements of the fourth quarter—and first quarter—growth story, too. Business fixed investment growth in the fourth quarter is expected to accelerate from the prior quarter’s anemic pace with solid single-digit annualized growth in non-residential construction, business equipment, and intellectual property. We expect modest growth in business investment to continue in the first quarter, driven by continued growth in business equipment and intellectual property investment. Encouragingly, economic surprises turned even more positive this week on the strength of the “hard” December and preliminary January economic data around employment and the labor market, retail sales, and even manufacturing output. Motor vehicle production increased 1.6% in December; initial jobless claims fell in the latest week to 187k, nearing a 54-year low; and the NAHB HMI jumped 7 points to 44, as expectations of future single-family home sales increased on higher foot traffic. The Mortgage Bankers Association corroborated this housing rebound, reporting rapidly rising mortgage purchase applications in the first half of January, with last week up 9.2% alone. December housing starts revealed a 6.1% increase in Q4 private starts, the biggest quarterly increase all year. Don’t get me wrong, it’s not going to be all roses and sunshine ahead. Inflection points can be tricky and economic uncertainty remains high. Even with this week’s upward revisions on consumer spending and GDP, we are still forecasting a real slowdown in both GDP and consumer spending growth in 2024 to 1.2% and 1.4% respectively Q4/Q4, down from 2.7% and 2.5% last year. Softer survey data, particularly for manufacturing, continue to point to a more severe U.S. economic slowdown ahead. The Empire State Manufacturing PMI for January was shockingly weak at -43.7—the worst reading since the pandemic began and one of the lowest ever. Any level below zero is considered contractionary. That said, this index can be extremely volatile month-to-month and only measures manufacturing sentiment in a small region of the country. For now, the Empire reading looks like an outlier that can be discounted, but we will get more manufacturing PMI data next week that could shed more light on the state of the sector. |
American Consumer: Resiliency Reigns |
| Retail sales in December were stronger-than-expected this week, an outcome that was evident in the ‘control’ metric that feeds into personal consumption expenditures. That was up 0.8% (vs. expectations of only a 0.2% increase), and even November was revised up a tenth to 0.5%. The spending momentum to end 2023 (and its likely cascade to start 2024), along with other recent data, caused us to upgrade our calls for Q4 and Q1 real GDP growth to 1.5% and 1.2%, respectively, from 1.0% and 0.6% (see Scott Anderson’s article for more details). Despite the surge in borrowing costs and erosion in purchasing power owing to high inflation, consumer spending continues to impress by its resiliency. Weighing in at around 68% of GDP, this is also imparting resiliency to the broader economy. Such resiliency not only lifts the odds of achieving a ‘soft landing’, but it also lowers the Fed’s sense of easing urgency (all other things equal). Indeed, the market now sees a March 20 rate cut as more of a coin flip, after pricing in a full cut around Christmas. The reasons for consumer resiliency are plentiful. Although the potency of some is lessening, combined, they still paint a picture of a household sector well positioned to help stick a soft landing and contribute to a quick take-off afterwards (refueled by rate cuts, to continue the metaphor). Below we list several reasons. Jobs: Payroll employment rose by 216,000 in December, which lifted the Q4 tally to just under 500,000. Although the latter is the lowest quarterly result since the pandemic, it still fits in perfectly with what the labor market was doing before the onset. It should be noted that household-surveyed employment growth was lackluster in Q4 and worth keeping an eye on, as a guide to what might happen to payrolls. Wages: The major metrics have slowed from their recent highs but remain elevated from a historical perspective. Average hourly earnings were up 0.4% in December or 4.1% y/y. The Atlanta Fed’s Wage Growth Tracker was 5.4% y/y or a smoothed 5.2% y/y. Meanwhile, the venerable Employment Cost Index (for civilian workers) increased 1.1% in Q3 or 4.3% y/y. Importantly, these measures are all running faster than inflation, resulting in real wage gains. Excess savings: From the onset of the pandemic through the summer of 2021, consumers amassed $1.9 trillion of excess savings (measured against the historical median saving rate of 8.5%). Since then, this cache of cash has been tapped to the tune of $1.8 trillion to help fuel spending in the face of higher inflation and interest rates (which made the Fed’s job a bit more difficult in the interim). Other studies suggest there could be higher amounts remaining, but they share similar conclusions to ours. There is relatively low excess saving remaining, and what’s left is likely skewed to higher-income households. This previous massive positive for spending’s pace is fast becoming a neutral, which is one of the reasons why we still have real PCE and GDP slowing during the current quarter (but staying comfortably above any negative outcome). Pent-up demand: Based on the (5-year) trend growth in real consumer spending before the pandemic, total outlays are now about 1 ppt above that trend. This mirrors 5 ppt above-trend performance for real spending on goods but 1 ppt underperformance for services. This suggests there is still some pent-up demand for the latter. Meanwhile, there are still pockets of pent-up pressure even for well-sated goods demand—automobiles come to mind. Past serious supply challenges left many would-be vehicle buyers on the sidelines, and they are now stepping back in. Both in December and Q4, vehicle sales were revving at their fastest speed in some 2½ years. Finances: Household balance sheets are very healthy. Debt as a share of disposable personal income (DPI), which was around 85% in Q3 according to the NY Fed, has been relatively stable if not trending down ever so slightly (this peaked near 117% at the height of the housing bubble in 2008). Consumers have been borrowing within their means. And the same flat-to-drifting-down pattern is shown by the debt service ratio (now about 9.8%). Consumers, in aggregate, also have some capacity to absorb higher interest rates. Meanwhile, net worth as a share of DPI was still off its record high of 8.3 times in early 2022; but at 7.4 times currently, this is still a historically high level. Since then, both home and equity prices are back on the rise. Consumer and broader economic resiliency are good things from a soft landing and societal perspective, but they do complicate the Fed’s push to restore price stability. They won’t prevent it from being restored, but it just means it might take a little longer to get there, which necessitates more Fed vigilance. In the same vein as easing financial conditions, resiliency is a recipe for policymakers feeling less rate cut urgency. |
Holiday Sales: A Strong Finish but Mediocre Performance |
| Back in October, we published our Holiday Spending Outlook. As a refresher, we forecasted fourth quarter retail sales excluding autos, restaurants and gasoline stations (our definition of holiday spending)—to climb 3.7% y/y. While holiday spending started slowly with 0.1% m/m growth in October, consumers accelerated their spending with strong gains of 0.4% and 0.7% in November and December respectively. The strong finish resulted in a mediocre annual gain of 3.6% in the fourth quarter. While down sharply from 6.4% in 2022 and the COVID-aid-fueled double-digit gains of 2020 and 2021, growth is on par with 2019’s performance (Chart 1). To help put this number in perspective, holiday retail sales in 2023 were a full percentage point below the long-run average of 4.6% from 1992-2023. Note also that retail sales are in nominal terms. When factoring in CPI inflation of 3.2% Q4/Q4, real holiday retail sales grew by just 0.4% over the past year. |
| The sharp deceleration was partly driven by weaker employment and wage growth. Average monthly job gains in the fourth quarter of 2023 were 165,000, down sharply from 285,000 in the fourth quarter of 2022, while average hourly earnings growth has slowed to around 4.1% y/y in the last quarter of 2023 from 4.9% a year ago. Another factor is the drawdown in excess savings, which the San Francisco Federal Reserve estimates was largely depleted by the end of September. Consequently, consumers had less firepower to fuel their spending. As an aside, spending at restaurants and bars, while not included in our definition of retail holiday sales, still climbed 10.2% after rising 13.5% in 2022, suggesting there is still pent-up demand for dining out. Holiday sales advanced in seven of the 10 segments included in our definition, with above-average gains in health and personal care stores, non-store retailers and electronics and appliance stores (Chart 2). Spending rose to a lesser extent at clothing stores and grocery stores, while receipts were flat at sporting goods stores and declined at building materials and furniture stores, ensuring the modest holiday spending gain. Notwithstanding the strong December finish to 2023, we expect real spending to cool further in Q1 amid restrictive monetary policy, slowing job and wage growth, and dwindling excess savings. Indeed, real consumer spending growth is forecast to ease to 1.8% this year from 2.2% in 2023 and 2.5% in 2022. This year’s forecasted pace is around half the long-run average of 3.3% from 1948-2022. The gradual slowdown is consistent with the increasing probability of a soft landing, not a recession. The consumer appears to be on the verge of bending but not breaking, thereby keeping the expansion intact, albeit at a more subdued and sustainable pace. |
