Below, Faucher shares insights on the following topics:
- Overview of Consumer Sentiment
- Tariff Impacts
- Key Indicators of a Business Cycle Change
- Bifurcation of the Consumer Market
- The Future of Online Retail and Disintermediation
- Consumer Readiness for a Recession
Overview of Consumer Sentiment
John Neuner: We have continued to see positive economic signs for the U.S. economy. Based on what you are seeing, can you give us your perspective on the psyche of the U.S. consumer heading into the important Q4 period for retailers and consumer companies, and how it is similar or different from prior years?
Gus Faucher: I’m feeling better about things today than I was two years ago—or even one year ago—for a couple of reasons. First is the recent upward revision to personal income and the savings rate. That means consumers are better positioned than I thought they were a year ago, or even two or three months ago. That’s obviously good news for consumers, and they’re starting off in a better position.
Another good sign: The August jobs report shows year-over-year hourly wage growth of 2.9 percent for the private sector. That’s the strongest it’s been since the summer of 2009. While it might come down a little bit in the near term, I think the trend is definitely for stronger wage growth.
With the unemployment rate consistently below 4 percent, we're seeing wage growth picking up. We've been waiting a long time for that to happen, and that’s another positive for consumer spending growth as we head into the holiday season.
Likewise, if we look at household financial obligations or debt as a share of after-tax income, those numbers look quite good. They are up a little bit over the past few years but are still far lower than they were heading into the Great Recession. Banks have been more cautious about lending, and consumers have been more cautious about taking on debt. So, generally, consumer debt is low relative to income, which means that households are making fewer payments on their debt, which frees up cash to spend on other things.
So that's another positive, as is household wealth. We have stock prices near record highs. House prices continue to improve: They're above where they were prior to the Great Recession but in a much more balanced housing market. Job growth is very good too: We're adding about 200,000 jobs per month this year. And the tax cuts implemented earlier this year reduced personal income tax by about $75 billion for 2018, which will increase to about $150 billion in 2019.
There are some negatives, though. Inflation is a bit higher, particularly with energy prices earlier this year, although there are some signs that that may be fading. Another negative is higher long-term interest rates, which can be a deterrent to spending on big-ticket items.
And then, finally, we do see banks pulling back a little bit on credit. There was some concern that banks were being a little too lax with their credit, so we have seen credit standards tighten somewhat over the past year or so.
But between job growth, stronger wage growth, good savings rates, and rising household wealth, those offset the negatives from higher inflation and interest rates, and tighter credit.
Tariff Impacts
Neuner: There is a good deal of extraneous noise in the news as we head into Q4. Do you expect the political rhetoric or the impacts of tariffs will slow consumers down?
Faucher: I think, first of all, that tariffs are a big downside risk, particularly for consumers. The Trump administration recently implemented another $200 billion of tariffs on Chinese-made goods. And there is the potential for tariffs on another $260 to $270 billion on Chinese goods on top of that. That certainly would raise prices and lead to higher inflation, at least temporarily. That, in turn, would be a significant negative for consumer spending. So far, however, it's not showing up in things like consumer confidence.
Neuner: Interesting. In terms of the tax cuts, do you think it will be a temporary bump, or will it have a more lasting impact?
Faucher: I think it's more the former than the latter—it’s going to provide a temporary boost. We do have stronger GDP growth this year and next, both from the tax cuts and from significant increases in federal spending. But then we expect to see consumer spending and GDP growth settle back down to where they were before we had the tax cuts.
Key Indicators of a Business Cycle Change
Neuner: As we look at where we are in the cycle, we’ve been in a long upswing. What are the areas or indicators that you focus on as you start looking for the next inflection point?
Faucher: We’re watching consumer fundamentals, which are obviously pretty good right now. We are also looking at business investment, which is being boosted at the moment by the tax cuts and by higher energy prices.
Commercial real estate is another area that we're looking at. Cap rates are near historic lows. Property prices have been increasing very dramatically. We are getting more supply, so we’re watching for overbuilding, which would put pressure on rents. And obviously the trade picture is very important for us and something we're watching now.
We’re also watching the Federal Reserve. We’ve seen it gradually raise rates this year, and next year, rates will probably top off somewhere between 2.75 percent and 3 percent. We're watching that, and for the possibility that the Fed tightens too much, causing a recession down the road.
Bifurcation of the Consumer Market
Neuner: Getting back to the consumer mindset, there has been a lot of focus on the bifurcation of the consumer in recent years. Those in the upper echelons seem to have benefited more from economic growth than those that are just starting to see the benefits of wage growth. How do you think that influences how the economy is going to perform over the next year or two?
Faucher: I actually think we are seeing more broad-based economic growth. If you look at median household income, it’s had three solid years from 2015 to 2017, the latest available data.
Particularly in the early years following the recession, we did see basically all of the gains going to upper-income households. But I do think that the broader growth that we've seen over the last two years, which I think is going to continue into 2019, is another indication of sustainable consumer spending gains going into next year.
Neuner: As we look at consumer spending, we have seen wage rates increase, but, as you note, inflation is also increasing. What do you think the net impact will be, and what do you think this looks like in the near and medium term?
Faucher: Until recently, wage growth was a little bit higher than inflation. More recently we've seen inflation pick up with higher energy prices, and they have been just about equal. Generally, I would expect inflation to slow as we work our way through the run-up in energy prices and as wage growth accelerates. I think we will see real income gains through the rest of this year and at least through the first half of 2019 due to stronger wage growth and lower inflation.
The Future of Online Retail and Disintermediation
Neuner: Does anything stand out to you in terms of where consumers are spending their dollars today versus recent history?
Faucher: The big thing we continue to see is movement away from traditional brick-and-mortar retailers toward online sales. For most of last year, we saw job losses in traditional retailing. We're seeing small gains now. That being said, they're pretty minimal, so I still think that there's a lot of room for this to continue.
I think that we are going to continue to see more spending going toward online sales and that traditional retail will continue to suffer. I also think that there is a continued movement toward the purchase of experiences and services rather than goods. This encompasses a broad range of things, like health care and financial services. But we are also seeing stronger growth in discretionary things like travel and tourism as people feel more comfortable and confident, and are willing to take vacations and that type of thing.
Consumer Readiness for a Recession
Neuner: When you look at the composition of the economy today, do you think the consumer is in better or worse shape relative to other late-cycle periods?
Faucher: Well, I think that consumers are in good shape right now. I don't see excesses on the consumer side, or on the housing side, so I think the next recession would more likely be business-led rather than consumer-led. Consumers are well-positioned: They wouldn't need to cut their spending as drastically as they did during the last downturn.
In fact, consumers are much better positioned now than they were heading into the Great Recession. Last time, we saw auto sales fall to 9 million a year. We wouldn’t see that this time. We'd still see a significant decline, but I think instead of falling to 9 million, they would fall from 17 million to 13 million or something like that.
Again, housing is much better balanced, so we wouldn’t see the loss of housing wealth that weighed so much on household spending last time around. Overall, while consumers certainly would take a hit if we had a recession, it wouldn’t be nearly as bad as it was in 2008 and 2009.
Published October 2018