Investment Comment
11th August 2023
Why has US spending been so resilient?
Like a warm dry summer day in the school holidays, the US economy has surprised many this year. Predictions of a recession have had to be delayed or put in the bin as the US economy has continued to grow in 2023 despite interest rates going up. There have been pockets of weakness, with the US housing market and manufacturing sector being in recession-lite conditions, but overall, the US consumer (and hence the US economy) continues to grow.
One of the main reasons that US consumer spending has remained so resilient in the US were the payments by the Government to individuals combined with household spending being greatly reduced during lock downs, the graph below shows this increase but also shows how spending post reopening has left the savings rate at half that of pre pandemic levels, potentially meaning spending from savings has now begun to taper out.
The San-Francisco Federal Reserve estimate that accumulated excess savings, in nominal terms, totalled around $2.1 trillion through August 2021, when it peaked, which is shown by the green area on the right hand chart below. The red area shows the drawdown of these excess savings, which has supported the strong spending of the US consumer. The current rate of savings drawdown suggests excess savings have been spent.
US Personal Saving as a % of Disposable Income
Source: Artorius, Bloomberg
Aggregate personal savings versus the pre-pandemic trend
Source: San Francisco Federal Reserve
Inflation isn’t really hurting.
Has inflation really been as bad as made out in the US? Inflation is real, especially for consumers facing ever rising prices. But reported inflation may be overstating the actual inflation for the typical US consumer. Inflation as reported in the data includes a component for US housing costs that actually doesn’t get ‘felt’ by the US consumer.
Unlike the UK, housing is part of U.S Consumer Price Index (CPI) inflation. In fact, in the U.S. Housing or shelter as it’s known, has 33% weighting in the index, so changes in housing costs can have a major impact on overall inflation. The graph below shows how much of an impact housing has had both pre and post pandemic to the point where shelter is now by far the largest driver of inflation in the US.
US inflation is now driven by ‘Shelter’
Source: Artorius, Bloomberg
Excluding ‘Shelter’ inflation has been much lower through 2023
Source: Artorius, Bloomberg
The two main components of shelter in the U.S. CPI are:
- Rents: The CPI includes a measure of rent, which reflects the cost of renting a primary residence. Rents can be volatile, and they can be affected by a variety of factors, including the supply and demand for housing, interest rates, and economic growth.
- Owners' equivalent rent (OER): OER is a measure of the cost of owning a home, including mortgage payments, property taxes, and maintenance costs. OER is calculated by comparing the rental value of a homeowner's property with the cost of renting a similar home.
While the cost of renting has increased above CPI’s figures, mortgage holders in the US typically have ‘locked-in’ their low interest rate cost and are immune to higher interest rates (unlike in the UK) until they decide to renew their mortgage. In the UK this is normally within 2-5 years, whereas in the US, the mortgage terms are typically much longer (10-30 years). So, the past 2 years of interest rate increases aren’t being felt by the US households who locked in their mortgages at lower rates (which is what happened).
New borrowers are having to face higher interest rates, which is one of the reasons for the lack of sales activity in the housing market, but existing borrowers are immune to the cost of higher interest rates. As shelter is now a key reason inflation is remaining so high, this source of inflation isn’t actually being ‘felt’ or experienced by the majority of US households.
So along with the excess savings acquired through the Pandemic supporting spending, US households have generally faced lower than headline inflation, which is likely to have contributed to better than expected spending and economic growth in the past 12 months.
If history had good news, does the future have bad news?
The surprise of 2023 has been the resilience of the US consumer. Both excess savings and inflation not being as impactful as the headlines data suggests have meant that the US consumer has carried on spending and the US avoided a recession.
The outlook for headline inflation is driven by ‘shelter’ inflation, and with falling house prices, this inflationary drive is expected to mean that inflation falls through the rest of 2023 and in 2024. Looking ahead, if inflation is falling because of the lower housing costs, then that ‘good’ news isn’t actually going to be ‘felt’ by the US consumer. Consequently, lower inflation may not be good news is reality.
Statements made by Home Depot, Target and Walmart, back up this fear, all warning of rising anxiety in US shoppers and stating non-essential purchases are being placed on hold so consumers can afford basic goods, despite the economic data suggesting lower inflation. Consumer spending remains ‘one to watch’.
Josh Young Portfolio Manager
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