17 April 2018
US households are feeling pretty good right now. Consumer confidence over the past three months is the strongest since early 2001, according to both the University of Michigan and Conference Board surveys. In particular, households are upbeat around current conditions, which might not come as a huge surprise given seemingly robust consumer fundamentals. The labour market remains healthy and continues to deliver strong employment growth, despite a small disappointment in March payrolls. Headline unemployment is at a multi-year low and broader measures of underemployment such as the U6 rate have fallen back to pre-crisis rates. While wage growth remains sluggish, there are signs that this is picking up slowly, helped by a combination of improved productivity and a tightening labour market. Against this backdrop, it is easy to see why precautionary household saving rates have been falling so quickly over recent quarters (see Chart 2). Add into the mix the recently passed personal tax cuts, which are set to deliver a 1.8% cut in average personal taxes this year and no wonder sentiment is so strong.
Given all this positivity, it is a little strange that household spending has been so restrained over the start of this year. Personal consumption expenditure fell in January and was flat in February in real terms. Even if we factor in a healthy rebound in March (as signalled by stronger retail sales), spending over the quarter as a whole looks set to post only a small contribution to GDP growth, and certainly much less than was seen at the end of 2017. What might explain this caution? One temporary factor could be delays to Federal tax refunds paid in February. This drag on expenditure should reverse as payments are delivered in March. Another explanation could be recent rises in inflation due to higher commodity prices, a weaker dollar and fading temporary drags such as the decline in telephony prices last year. However, even taking this pick-up into account there are few sign of an inflation squeeze, with household real incomes up a robust 4.1% annualised over the past three months. There is little evidence of a credit squeeze either. While banks have been tightening standards for consumer credit, including consumer loans, credit cards and auto loans, we have only seen a moderate slowdown in consumer credit growth over recent months (see Chart 3). The final and maybe simplest explanation might be that consumers are taking a temporary breather following recent robust spending. Indeed, given the strength in consumer fundamentals we expect consumption to rebound over coming quarters.
There is one factor which should raise concern over spending from a longer-term perspective. Productivity, which forms the long-run foundations of real income growth, has clearly weakened from its pre-crisis growth rates. Over recent years the effect of this shortfall on purchasing power has been mitigated at various points by low inflation, declining personal savings and the recent tax giveaway. However, these temporary boosts should not hide the fact that longer-term spending will be restrained, unless the US can sustainably generate higher productivity and hence real income growth. On a positive note the recent cyclical upswing does look to have helped on this front, although structural reform efforts are likely to be required to engineer a longer-term pick up in productivity growth.