The global economy has taken a hit this year, with rampant inflation causing soaring prices at the pump and in stores, elevating mortgage rates, slowing growth and more. One bright spot has been continued consumer spending. But, like Atlas carrying the weight of the world on his shoulders, how much longer can consumers sustain this spending spree and provide fuel to the economy?
In episode 46 of The Flip Side, Global Chairman of Research Ajay Rajadhyaksha and Head of Economics Research Christian Keller debate whether consumers are pulling back on spending, examining factors such as household savings rates, unemployment figures, and the link between consumer confidence and spending.
Ajay Rajadhyaksha: Welcome to the Flip Side. My name is Ajay Rajadhyaksha. I'm the Global Chairman of Research at Barclays. And I'm joined today by Christian Keller, our Head of Global Economics. Thanks for joining me, Christian.
Christian Keller: Thanks for having me, Ajay.
Ajay Rajadhyaksha: Today, we are going to talk about the economic health of the consumer. Specifically, is the consumer finally starting to pull back on spending, to a greater extent than financial markets and central banks are expecting? Christian, it feels like the US economy has taken hit after hit this year. Oil is near $5 a gallon. Overall inflation is running at 9%. Large retailers are complaining about excess inventory. Mortgage rates are three percentage points higher than last year. And the one thing that has been holding up is US consumption. Almost like Atlas with the weight of the world on his shoulders. The question is, how long can that continue?
Christian Keller: Well, I think for a while longer. In this debate, I plan to argue that the consumer is totally fine and consumption will keep holding up.
Ajay Rajadhyaksha: And I will take the other side. I will argue that consumers are finally starting to pull back on consumption.
Christian Keller: Exhibit A for me, Ajay, is the state of the balance sheet for US households. They are in great shape and we know why. Specifically, people were forced to save in 2020 and 2021 because of COVID. You couldn't go out, couldn't travel, and there was only so much you could spend on goods. These forced savings meaning that the US households have an extra 2 to 3 trillion over and above what they would have if COVID never had happened.
And by the way, that's not only true for the US. Take the UK our home market. Once again, households have anywhere from 8 to 12% of GDP worth of excess savings, just like in the US. That's a lot of cushion, Ajay.
Ajay Rajadhyaksha: Yes. But most of these savings sit on the balance sheets of wealthier households. And that is true in both the US and the UK as well. Meanwhile, people at the lower end are getting totally hammered by very high prices, not just at the gas pump, but also at the grocery store. And remember, lower income households spend a lot more of their paychecks on necessities. They received stimulus checks last year. And as the effects of these checks fade into the distance, they are really feeling it.
Christian Keller: Yeah, but one of the features of aggregate US consumption is that the top 20% account for 80% of consumer spending. So, yes, the very bottom is hurting, but in aggregate, that may not translate into as much of a negative for the economy as you think. And most of the people who have this excess cash are spending, Ajay. Not on goods but on services. For two years, they were all held back by COVID. But now restaurants are full, flights are bursting to capacity, and there's a tourism boom underway. This money is being spent.
Ajay Rajadhyaksha: So far. Money is being spent so far. But I believe things are starting to slow down. I recently published a note with our data sciences team where they looked at our own US credit card data and showed that the pace of spending is decelerating and that this is happening in both high-end and low-end goods, meaning all sorts of consumers are pulling back. Our spend trends data cities in the UK are pointing in the same direction. Things are slowing down.
Christian Keller: But Ajay, we always knew this was the year that consumption would take away from goods to services. Is that such a surprise?
Ajay Rajadhyaksha: But people also use their credit cards for services, right? For restaurants, for airline tickets, etc. And there again, we are seeing a clear and quick slowdown.
Christian Keller: But be careful to read too much, too quickly into high frequency data. That's why aggregate economic numbers matter so much. And yes, I know you're going to say the last year's retailers were disappointing, sure. But it's one data point that doesn't make a trend.
Ajay, also look at where the US jobless rate is. It's 3.6%. The US has been creating 400 to 450K jobs every month. Household financial wealth is very solid given how much home prices have risen. If everyone is employed, and there's a lot of excess savings and large amounts of financial wealth, I struggle to see why there should be a big pullback.
Ajay Rajadhyaksha: Well, I would say the US jobless rate itself is a pretty backward-looking indicator. In October 2008, after the financial crisis, the US jobless rate was just over 6%, and a year later, it peaked at 10. But I do get your point about 400,000 to 450,000 additional jobs a month. And if that continues, I would agree. Households are fine and so is consumption.
But once again, we are picking up signs that the mortgage industry is on the verge of layoffs. Big tech hiring intentions have turned negative. The Fed is on the warpath. And as for financial world, well, the market has made a pretty big dent in both stock and bond wealth this year, hasn't it? It's asking for a lot to say that the consumer will ignore these hurdles and blithely keep spending.
Christian Keller: Yes, stocks and bonds have dropped, but on stocks, valuations are still comfortably above pre-COVID levels, and the majority of households hold their wealth in their house, and home prices are still rising. And guess what else is rising? Wages. The Employment Cost Index, which the Fed looks at, was running at 4.5% at the end of the first quarter, the fastest pace in two decades.
Ajay Rajadhyaksha: Once again, the question other indicators, higher frequency indicators suggest a softening. For example, average hourly earnings clearly suggest that wages are moderating and look at real wage growth. If inflation is running at nine and wages are running at 4.5%, that's a big, big hit in real terms. Also, look at what consumers are saying. Those consumer confidence numbers really are terrible, especially in terms of future expectations. Consumers feel as bad about the world as they have in many, many decades.
You mentioned the UK before. So I will add here that UK consumer confidence is similarly poor. It's at the lowest levels since 1973. Across the West, consumers are telling us that they feel really, really uncomfortable with their economic outlook.
Christian Keller: Yes, but I would question whether consumer confidence levels are truly tied to consumer spending. Yes, the actual levels of consumer confidence are very poor. But we have often found that they don't tell you that much about the direction of consumer spending. In this case, I also suspect that consumers are overreacting to near-term inflation and that is what is causing them to be so gloomy.
Ajay Rajadhyaksha: Well, I'm not arguing that the level of consumer confidence is one-to-one tied with consumer spending, but I am talking about the change. Consumers feel far worse about the world than they did just two months ago. And that has to show up, I think, in their spending decisions relative to two months ago. And I think it will and soon.
Christian Keller: I will concede this much to you, Ajay. I suppose it is possible that consumers just turn precautionary and decide to pull back, ignoring their large levels of savings, financial wealth, and the labor market, perhaps. Right now, though, there isn't any sign of that in the aggregate data. In fact, the US savings rate has dropped sharply from the end of last year. Consumers are willing to dip into their store of excess cash and used to spend it, even though things cost a bit more than they used to.
Ajay Rajadhyaksha: Well, look, I wouldn't call it a bit more Christian, and I would argue that the savings rate being so low helps my argument. Seriously, how long can consumers sustain spending when their wages are clearly going up far less than prices? Also, you mentioned the increase in services spending. Well, the problem there is that those are also the places where prices are rising strongest.
I mean, look at airline fares. In the last few inflation reports, they are up 18% one month, then up another 12% the next month. At some point, you do decide to put off that family trip, and I think you will start to see it soon.
Christian Keller: I still think you are underestimating the staying power of the US consumer, Ajay. Ultimately, the fundamentals should win out. The trifecta of low unemployment, large savings, and accumulated financial wealth is a strong one. US households are fine and will keep spending.
Ajay Rajadhyaksha: And I think you are underestimating how big a shock the combination of decades high inflation, coupled with the recent collapse in the market, coupled with the Fed on the warpath, adds up to.
Look, I clearly hope that you are proven right in this debate, Christian. Your outlook is clearly the one that all of us would prefer. But like we said at the start of this debate, the consumer has been one of the few bright spots in the US and the world economy this year. And if they are pulling back, that's a big deal.
I guess we will find out soon enough which side wins out. Until then, though, our clients can read our most recent research pieces on this topic, including the one titled, The US Consumer Might Be Starting to Turn, as well as our latest Global Outlook, The Summer of Discontent, both on Barclays Live.
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This podcast series features lively debates between Barclays’ Research analysts on important topics facing economies and businesses around the globe.
About the analysts
Ajay Rajadhyaksha is Global Chairman of Research at Barclays, based in New York. He drives the global macro research and strategy effort including economics, rates, FX, commodities, emerging markets, and asset allocation. Since joining Barclays in 2005, Ajay has held various positions, including Head of Macro Research, Co-Head of FICC Research and, before that, Head of US Fixed Income Research and US and European Securitised Research.
Christian Keller is Head of Economics Research at Barclays, leading a global team covering both Developed and Emerging Markets. Christian is based in London and joined Barclays in 2007 from the International Monetary Fund (IMF) where he had worked since 1999. Based at the IMF headquarters in Washington D.C., he worked on IMF programs with Emerging Market economies in Europe, Latin America and Asia, and served as the IMF’s Resident Representative in Turkey from 2005-7. Christian graduated with a PhD in Economics from University of Köln, Germany, and holds a joined-MA in Economics and Finance from University of Köln and HEC, Paris.