With markets reeling from recession fears, the world is watching the resilient U.S. consumer, now in the strongest position since before the financial crisis — so far.
By many measures, the consumer is doing well, unscathed by the trade wars that have hit global manufacturing and business investment.
In the U.S., consumer sentiment is high; household balance sheets are strong; employment is still solid, and spending has been growing. The latest evidence of the consumer’s durability will be Thursday’s July retail sales report, expected to be up by 0.3%, according to Refinitiv.
“The consumer has played Atlas, carrying the economy, and it can do that, but the muscles come from job gains and wages,” said Diane Swonk, chief economist at Grant Thornton. “You can say the consumer is going to carry you through. They will if they keep their jobs and they don’t get scared.”
The economy added 164,000 nonfarm payrolls in July, nearly as expected, and also about the average monthly gain for the year. In 2018, the economy created 223,000 jobs a month, but economists see the slower pace as still solid. The unemployment rate is at 3.7% and wages gained 3.2% year over year.
But recession clouds are hanging over the economy longer term, as some investors fear the impact of trade wars and the global slowdown will spill over to the U.S., and the Fed will not respond aggressively enough.
Weak and volatile market conditions can cause a pullback in consumer spending, as it did in December when the stock market was spiraling lower.
“We think the consumer is really the key to keeping this recovery going. It’s kind of the only sector, along with government spending, that’s really had sustained gains in recent months,” said Jonathan Millar, deputy chief U.S. economist at Barclays. Consumers make up roughly 70% of the U.S. economy. “That doesn’t mean we’re on the cusp of a recession because consumer spending is something like 70% of the economy. Consumer spending can keep the recovery going for some time. The durability of the gains in payrolls and the willingness of households to spend is going to be a key issue when thinking about how long this recovery is going to go on.”
Stocks were falling sharply Wednesday, with the Dow down more than 700 points, as investors worried about a new recession warning coming from the bond market. There has been a significant drop in Treasury yields, since last month’s Fed meeting. The yield on the bench mark 10-year Treasury, which moves opposite price, was at a low 1.57% Wednesday, a half percentage point lower than just two weeks ago.
The unusually volatile move in Treasurys has resulted in an inverted yield curve, meaning the shorter duration 2-year yield is higher than the 10-year yield. That is a widely watched recession signal, with the 10-year, reflecting a flight to safety and concern about the economy longer term, and the 2-year slightly higher, more an indication of where the Fed is currently targeting short-term interest rates.
However, there is a silver lining in the sharp drop in interest rates: Even if they have succeeded in spooking investors, they could be a big plus for consumers. The benchmark 10-year Treasury yield influences mortgages and other consumer and business loans, and borrowers are looking at lower rates.
“The early litmus test as to whether that’s good or bad are the mortgage applications,” said Ward McCarthy, chief financial economist at Jefferies. “The refinancings support the balance sheets of households. It’s like a tax break. And the purchase apps rising provides support for housing.”
Mortgage applications, reported earlier Wednesday, jumped nearly 22% last week as homeowners rushed to lock in new low rates. Interest on a 30-year fixed mortgage was 3.93% and falling. The issue is whether the low rates ultimately whip around and hurt lenders, causing them to tighten standards and cutting off lending.
Joseph LaVorgna, chief economist Americas at Natixis, said the strength of the consumer cannot stop a recession, if it’s going to happen. The average time between an inversion on the yield curve and a recession, since the late 1990s, has been about 22 months, according to Credit Suisse.
“Retail sales take on a lot more significance than what would normally be the case” on Thursday, LaVorgna said. “The three-month rate of change in retail control is over 7.4%.” That is at the high end of a recent range in control sales, which do not include autos, gasoline or building materials.
“Relative strength in consumer spending, in and of itself, is not enough to keep the economy out of recession. The other 30% of the economy tends to be weak enough and volatile enough that it drags the economy into a recession,” said LaVorgna. “What it means is you wont’ have a deep recession.”
President Donald Trump said Tuesday he would hold off on implementing new 10% tariffs on many consumer goods included in the $300 billion in Chinese goods he had originally targeted for Sept. 1. Trump has delayed the tariffs until mid-December, saying he did not want them to impact the Christmas holiday season.
Tom Donohue, CEO of the U.S. Chamber of Commerce, told CNBC on Tuesday that Trump delayed tariffs in part to avoid a recession during the upcoming 2020 presidential election.
Millar noted that the tariffs implemented so far have been on intermediate goods that only indirectly affect consumers. The next round, however, would have a bigger impact.
The bigger fear is that the business climate will become even more negative and ultimately hurt the consumer. “That’s the big question we’re asking ourselves. The moment that businesses stop hiring and start losing confidence in the broader outlook, not just businesses losing confidence in where they should put factories, or where they should invest. Once they say we don’t know if we should take on additional workers because we’re concerned about the outlook, that’s something you should worry about, ” Millar said. “Potentially, you may see a recession dynamic unfold.”
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