Seven years into the recovery, a key driver of economic growth continues to demonstrate a frustrating conundrum: Consumer spending remains respectable, providing a much needed pillar to the global economy, but it has consistently failed to accelerate out of low gear. Personal consumption is stuck well below its historic average, despite some improvement at the end of 2015. Narrower measures of discretionary spending such as retail spending remain muted even by the diminished standards of the post-recession environment.
Sluggish consumption was understandable for most of the recovery. Households were struggling under a crushing debt load, built up during a multi-decade expansion in credit. In addition, wage growth was noticeable primarily by its absence.
More recently circumstances have changed. Job growth has been strong and wages have finally started to firm. Household balance sheets have also improved. U.S. household wealth recently hit a record $86 trillion.
Meanwhile, the growth in household debt has largely stalled, although rising student and auto loans may challenge this trend. The ratio of debt-to-income is now at 104 percent, the lowest since 2002. Further easing the burden, the persistence of low interest rates has pushed debt servicing costs to a record low of barely 10 percent of disposable income. Finally, low oil prices have produced a windfall for middle income consumers.
Unfortunately, none of this has changed the basic dynamic: Consumption remains muted. In understanding why, it is important to focus on three factors:
The longer-term trend towards slower income growth and household consumption
As is widely recognized and discussed, there has been a multi-decade deceleration in income growth. And despite a recent uptick in wages, real income growth remains soft relative to history. Not surprisingly, this is the biggest obstacle preventing consumption from returning to its long-term trend.
Echoing the slower income growth, household consumption has been sliding for years. Since 2000 adjusted retail sales have averaged roughly 4 percent year-over-year, a significant decline from the 1990s. Similarly, real personal consumption averaged 3.7 percent between the late 1940s and the end of the 1990s, but has averaged just 2.3 percent since then.
Americans are saving a bit more
After many decades of decline, the savings rate appears to have bottomed. One of the best predictors of consumption is the change in the savings rate, and declining savings is typically associated with a faster pace of spending. In fact, the change in the savings rate, together with the rate of income growth, have historically explained more than 75 percent of the change in spending.
The financial crisis and its aftermath arrested the multi-decade decline in the savings rate. Most recently the savings rate has been heading higher, but at 5.4 percent it is still well below the long-term average and arguably has further to rise. A higher savings rate is ultimately a healthy and necessary development, but it comes at the expense of today’s consumption.
Households are missing the tailwind of rising debt
Over the past twenty years—a period that encompassed both the long-term rise in borrowing and the subsequent deleveraging—the direction of savings and the rate of consumer credit growth have consistently moved in opposite directions. Households have tended to save less during periods in which they borrowed more. In the aftermath of the financial crisis, a few new found frugality, mostly borne of necessity, caused many households to borrow less and save more. The future direction of the savings rate is likely to be somewhat tied to the ability and willingness of households to raise their borrowing.
The interplay between income, savings and borrowing matters to the economy and the market. With manufacturing tepid on a global basis, China decelerating and Europe struggling under a newly resurgent euro, a weary U.S. consumer is once again bearing a disproportionate share of investor hopes. But delivering on those expectations, and keeping the recovery on track, will require an acceleration in income, a drop in the saving rate an increase in borrowing, or some combination of all three.
Russ Koesterich, CFA, is Head of Asset Allocation for BlackRock’s Global Allocation Fund and is a regular contributor to The Blog.