This Week’s Developments in the US Economy

Understanding the US Consumer

Consumer spending, which typically constitutes over two-thirds of US GDP, has been robust and has played a crucial role in driving US economic growth. Headline consumer sentiment readings from the past few years have told a different story, and getting behind the headline sentiment data reveals to some degree why consumer spending has remained resilient for some time but may be at risk of decelerating. This week's release of retail sales data was unexpectedly positive, which has boosted second quarter GDP projection with the Atlanta Fed's GDPNow forecast increasing from last week's 2.0% to 2.7%, rising higher from the prior week’s reading of 1.5%.

Looking at more granular level data from the University of Michigan’s consumer sentiment survey, we note consumer pessimism is most concentrated in perceptions of financial conditions, home and durable goods purchases, and retirement prospects. While pessimism is evident in sales of big-ticket items like homes and durable discretionary goods, other areas of spending have remained robust, driving June retail sales higher to 2.3% year-over-year. Notably, when excluding motor vehicles retail sales rose by 3.4% year-over-year. And despite these figures falling below their post-GFC averages of 3.9% and 3.5%, respectively, we still see bright lights in pockets of the data. A key driver of recent growth was non-store (online) spending, which rebounded with a robust 1.9% month-over-month increase and the highest year-over-year growth rate across all categories at 8.9% in June.

Finding Surprises in Consumer Sentiment Across Demographics
As mentioned earlier, headline sentiment data can be misleading, especially as it appears misaligned with consumer activity in some categories. In July, the preliminary figures from the University of Michigan's Consumer Sentiment Index dropped to 66, indicating depressed readings since the onset of the pandemic. This index comprises two primary components: current economic conditions and consumer expectations. Historically, sentiment regarding future conditions has typically fallen slightly below that of current conditions--although this gap has begun to narrow recently. Analysis by age groups reveals intriguing patterns: the 18-34 age group has shown more optimism about current conditions compared to the 35-54 age group. Consumer expectations have seen a similar dynamic. However, recent readings have indicated a shift in both groups’ optimism aligning more closely regarding future conditions. These findings highlight the differing but also evolving dynamics in consumer sentiment across different demographic segments.

Heightened Levels of Pessimism
Examining the more granular components influencing consumer decision-making offers deeper insights into recent data trends, such as the latest retail sales numbers. As of June, many respondents across the younger and middle-aged cohorts perceive their current financial situation as worse compared to a year ago. Furthermore, consumers have also posted higher levels of pessimism regarding home buying conditions and retirement prospects.

Home Buying Conditions

In June, almost 90% of respondents assessed the current market economic conditions as a "bad time to buy" a home, many pointing to high prices and interest rates (see accompanying visual). Contrary to the spread seen between younger and middle-aged demographics on current conditions, both groups are closely aligned in their pessimistic views on home buying conditions. Looking at future conditions, however, a notable divergence emerges when consumers are asked about the expected median home price increases over the next year. Younger respondents anticipated a 3.4% increase following the upward trend in housing prices over the last few years, but the middle-aged cohort only expected a 0.4% rise, perhaps expecting a decrease in prices, rates, or both. The discrepancy across the age groups is particularly significant given that 35 years old is typically the age associated with home buying, according to the National Association of Realtors. Essentially, the typical renter age demographic anticipates higher home price increases compared to the typical homeowner demographic. A perception which may make renters hesitant regarding the pursuit of homeownership but may be more realistic than the expectations of the middle-aged group considering the median home price has increased by 57.5% on a cumulative basis and 14.2% on an annualized basis since the beginning of 2020 and the onset of the pandemic.

Retirement

The greater pessimism for the housing market, a key source of wealth generation in the US, is likely tied to rising levels of consumers who believe they will not be able to retire comfortably (see accompanying visual). Also driving longer-term sentiment are consumers’ expectations for inflation. Consumers believe inflation, which stands at 3% as of last week, will decrease only by 10 bps over the next year. This sentiment has been fairly durable as consumer expectations from one year ago recorded 3.3%, which is slightly higher than current levels. Actual inflation data, alongside consumer perceptions of future price increase have likely influenced sentiment about retirement prospects. Across both age groups, respondents believe that achieving a comfortable retirement has become more challenging with49% of those aged 18-34 and 47% of those aged 35-54 perceive a decline in the ability to retire comfortably when compared to five years ago.

Durable Goods & Retail Sales

Consumer perceptions regarding the buying conditions for durable goods, which represent a larger expense on the household balance sheet and can be a gauge of current economic sentiments, have been largely negative over the past two years. The latest retail sales data underscore this negative sentiment, consumer sentiment and activity are both aligned in terms of decreased spending on big-ticket items. Durable and discretionary goods such as furniture and sporting goods, hobbies, musical instruments, and bookstores experienced notable declines over the past year. In our view, the recent retail reading and the expected positive impacts on quarterly GDP growth may be short-lived. We believe this expectation is shared by Fed members who have recently shifted focus in emphasizing the state of the labor market, which is likely to go together with consumer spending on a go-forward basis.