- Prospects are improving for consumers in 2014.
- Jobs and incomes are expected to grow faster, wealth will expand, and credit will become more available.
- The result will be faster spending growth, stronger confidence, and improved credit quality.
- Risks to this outlook are significant, starting with the federal government's fiscal situation.
The coming year could bring some long-awaited relief to consumers. With federal fiscal restraint set to fade and construction and business spending set to rise, jobs will become more abundant and incomes will increase more rapidly. This will lift equity and house prices, continuing the rebound in wealth. Consumers will finally feel comfortable unleashing their pent-up demand for more than just cars. Spending growth will support an accelerating economic recovery. Borrowing will increase, but credit quality will continue to improve.
This rosy scenario constitutes the Moody’s Analytics baseline forecast. Yet risks to the outlook are significant, starting with the path of federal fiscal policy. The forecast assumes that Congress can pass a budget and raise the Treasury debt ceiling with more than a few hours to spare before the next crisis is triggered. The forecast also assumes that the Federal Reserve can unwind its monetary stimulus without causing a spike in long-term interest rates. It further assumes that economies overseas can absorb the rise in U.S. interest rates without significant disruption, and that energy and other commodity prices remain stable. Finally, the outlook counts on a rebound in U.S. business formation.
Spending depends on income
Consumer spending has grown at a sluggish pace near 2% per year during most of the recovery, and was slower in 2013 than in any year since 2010, because of weak income gains. Consumers have tapped other available resources; the saving rate has fallen by nearly 2 percentage points from its peak in early 2009.
Incomes have flattened over the last two years, mainly as a function of federal fiscal restraint. Taxes rose with the end of the two-year Social Security payroll tax holiday, higher rates on upper-income taxpayers and other increases related to the Affordable Care Act. Federal transfer payments have also grown more slowly as the economy improved and temporary benefits such as emergency unemployment insurance payments expired.
The cost of uncertainty
The federal government also affected incomes indirectly, in part through the budget confrontations and shutdowns that increased uncertainty, undermining businesses' willingness to hire and invest. Employment growth remains under 200,000 per month, and the level of employment remains below its prerecession peak hit nearly six years ago. Weakness in the labor market has caused wage income to increase far more slowly than gains in employment would normally suggest, and consequently dragged on spending growth.
Fortunately, these weights are lifting and will continue to do so next year, assuming no change to current law. If a budget and debt-ceiling deal is reached comfortably ahead of the deadline, fiscal uncertainty will continue to dissipate, supporting business spending and hiring.
Other factors also point to stronger job growth. Construction activity is expected to increase rapidly as builders respond to rapid house price appreciation, a sign that demand is rising faster than supply. Builders still face constraints on credit and skilled labor, but as construction increases, employment will as well. Each new single-family housing start generates roughly four new jobs in construction, manufacturing, transportation, finance and related industries. Each multifamily start can generate up to two jobs. Faster job growth will gradually support higher wages.
Wealth gains release pent-up demand
As both house and stock prices rise, more consumers will see their net worth surpass prerecession peaks, which could further support increased spending. Wealth effects will be smaller than they were before the recession, but they will still raise the trajectory of spending growth.
All of this will help release pent-up demand. Consumers have been holding back on purchases for some time; the stock of consumer durable goods had an average age last year that was higher than at any time since 1945, according to the Bureau of Economic Analysis. Only two of the 17 segments reported by the BEA had a decline in goods' average age last year. Slow spending growth this year suggests pent-up demand rose further. This is not limited to durable goods, but likely exists for travel, entertainment and apparel as well. New jobs require new wardrobes, while growth in restaurant spending has been unusually weak relative to spending at grocery stores since the recession.
Spending is expected to accelerate rapidly in 2014. Durable goods will continue to lead growth, although service spending will lead the acceleration, driven by housing and the release of pent-up demand for travel and entertainment-related segments.
The strengthening economy will continue to help consumers pay their debts. Measures of credit quality are expected to improve in 2014 in most areas except for auto loans, where lending standards have already been eased, and student loans, where they were never tightened. Credit-card charge-offs are expected to fall to new record lows.
Credit quality will improve even as overall consumer debt grows. With higher demand, lenders will find ways within new regulatory constraints to make more loans available. This is already occurring for autos, but will spread at least to credit cards as well. At the same time, the recent decline of mortgage debt due to foreclosures will slow, and overall consumer indebtedness will rise.
The outlook for 2014 is optimistic, but the risks are substantial. Another government shutdown or debt-ceiling crisis, or even the threat of one, would undermine consumer confidence and deter businesses from hiring and investment. At best, the economy would continue to muddle along at current growth rates, and worse outcomes are clearly possible. Spending gains could slow, as consumers have less room to reduce saving they have in recent years.
Monetary policy presents another formidable risk. If the Federal Reserve missteps in its withdrawal of monetary stimulus and long-term interest rates spike, the housing recovery and equity prices would be set back. Consumer spending would be hurt, as would business hiring and investing. The sharp increase in rates last summer highlighted this risk.
The expected rebound in construction is important to the outlook. If supply or credit constraints prevent this, jobs will not be created, as expected and incomes and confidence will not grow rapidly.
Finally, several risks come from overseas. Even a gradual increase in U.S. interest rates could undermine growth in emerging markets, threatening exports and equity prices. Oil prices are always sensitive to events in the Middle East, and a spike in prices would act like a tax, reducing consumers' ability and desire to spend.
Scott Hoyt is a Senior Director at Moody's Analytics.
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