This Week’s Developments in the US Economy

The Outlook Improves: The Implications of Strong US Consumer Activity

The implications of a strong US consumer directly impact demand-driven sectors across the economy. Our base case is that this level of activity has room left to run, which is contrary to those who see more headwinds than tailwinds. We see the lack of home sales—at a slow pace not seen in over a decade—translating to higher consumer activity. Why? Because consumers are not saving despite higher interest rates, and, instead of leaving capital at rest, consumers are continuing to drive the economy. And while consumers are spreading spending across services and goods, we are seeing a decline in purchases that typically involve some sort of debt (i.e., “big ticket” spending, see accompanying visual). We maintain that the consumer performance outlook, influenced by a nuanced interplay of interconnected factors, will demonstrate continued strength and momentum in the coming quarters. 

Consumption Spending and Homeownership: The Evolving Consumer
Robust consumer spending, driven by a strong labor market, has played a pivotal role in boosting the economy thus far, contributing to over half of the 4.9% annualized growth in GDP for Q3 2023 (see accompanying visual). However, a shift has occurred since Q2 2023, with a discernible decline in real disposable income, culminating in negative territory in Q3 2023. This shift, though concerning, is accompanied by consumers making strategic decisions due to the increasing unaffordability of homeownership. Consumers are, in fact, delaying their home purchase decisions, illustrated by the rise in one-year ahead home price expectations versus a recent decline in the three-year ahead expectations (see accompanying visual). In short, consumers appear to believe that more favorable conditions for homebuying may emerge, but they are not quite there yet.

Where the Money Is Going: The Retail Reshuffle
The broader shift from interest rate-sensitive categories to a mix of nondurable goods and services is evident in the advanced retail sales estimate for September. We believe these retail-heavy spending patterns, which rely heavily on logistics infrastructure, are likely to persist as prevailing yield levels and the Treasury's substantial borrowing needs could potentially keep consumers focused on retail spending and away from big ticket spending. Businesses appear to agree as inventories are increasing in response to an active consumer, which is likely to lower inflation pressures amid surging consumer activity. 

This Week’s Developments in the Global Economy

Economic Softness in the Euro Area Could Turn Positive If Consumer Activity Returns

The German economy is increasingly important for understanding relative strength in the global economic landscape and for the trajectory of the Euro Area overall. In recently released economic forecasts by the IMF, the German economy may now be the third largest in the world, with nominal GDP anticipated to surpass Japan’s GDP in USD terms. As major central banks have shifted into an extended pause, the key question for market observers is how much room is left to run for regional and global economies. In many respects, Germany may serve as a harbinger for the Euro Area and a potential signal for global growth. Multiple forecasts suggest a rebound in German economic activity in 2024 that underscores the expectations for a recovery in consumption, which would have positive effects on the Euro Area as a whole—but a recovery is anticipated to occur slowly.

Economic Deceleration and a Path to Recovery in 2024
As a bellwether for the Euro Area’s economy, Germany’s muted growth since H2 2021 is below the previous decade’s average and highlights below-trend performance. Germany, a significant contributor of the Euro Area GDP, saw a Q3 quarter-over-quarter growth figure of -0.1%, mirroring the Euro Area’s Q3 GDP at -0.1%. In Germany, the contraction was smaller than expected and impacted by a drop in household final consumption when compared to Q2. The German government and the European Commission have both forecasted a 0.4% contraction of the German economy in 2023. However, the European Commission projects a recovery in 2024 with a 1.1% growth, just 0.1 percentage points shy of the 2010-2020 annual average as reported by the German Federal Statistical Office. 

Highlighting the importance of consumer activity, both abroad and in the US, improvements to the outlook are grounded in household finances. Forecasters anticipate that the German economy is poised to take a positive turn, which is largely based on anticipated improvements in consumption. Easing price pressures and positive wage growth are anticipated to boost a recovery in consumer spending. Illustrating these points, real earnings turned positive year-over-year in the second quarter for the first time in nearly two years, and GfK consumer sentiment figures and increases in the savings rate highlight the potential for strengthening household balance sheets that could help propel a modest recovery.