The Labor Market Continues to Be Resilient

Though U.S. consumer spending was surprisingly robust in 2022, this poses both new and continuing challenges as households draw down their excess savings.

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Michelle Weaver: Welcome to Thoughts on the Market. I'm Michelle Weaver from the Morgan Stanley U.S. Equity Strategy Team. 

Sarah Wolfe: And I'm Sarah Wolfe from the U.S. Economics Team. 

Michelle Weaver: On this special episode of the podcast, we'll discuss how the U.S. consumer is faring. It's Tuesday, February 14th at 10 a.m. in New York. 

Michelle Weaver: The health of the consumer is critical for the equity market, and consumer spending last year helped companies continue to grow their earnings. Sarah, can you give us a snapshot of the overall health of the U.S. consumer right now? Do people still have plenty of savings, and what are you expecting around consumer savings for the rest of the year? 

Sarah Wolfe: The U.S. consumer was extraordinarily strong in 2022, despite negative real disposable income growth. For perspective, spending was about 3% growth year over year in 2022, and real disposable income was negative 6.5%. Part of that was inflation eroding all income gains, but it was also a tough year as we lapped fiscal stimulus from 2021. So what got consumers through negative 6.5% real income growth? It was this excess savings story. Consumers tapped their excess savings pretty significantly, and we estimate that the drawdown was roughly 30% from its peak. However, when we look into 2023, we don't think consumers are going to be tapping into their savings reserves quite as much. 

Michelle Weaver: It sounds like households draw down quite a bit of their excess saving. Is there any danger that they're going to run out? And if that's the case, when do you think that will play out? 

Sarah Wolfe: So we don't think 100% of excess savings are going to get spent ever. Remember, savings is not cash in your wallet, it's just anything that hasn't been spent. So some of these savings have moved into longer term investment vehicles as well. We think that an additional 15% will get spent in 2023, and 10% in 2024, after 30% drawdown last year. This slower drawdown in the excess savings will allow the savings rate to recover after sitting at a two decade low in 2022 at roughly 3%. But there are important divergences when you look at the distributional holding of excess savings. For example, the bottom 25% has drawn down over 50% of their excess savings, compared to 30% overall. And we believe they're on track to run their savings dry by 2Q 2023. 

Michelle Weaver: Great. And then income, of course, is another really important source of spending for consumers. And the January jobs report we got was a big surprise. And the labor market continues to be pretty resilient without any clear signs of stopping. I run a proprietary survey in conjunction with our Alphawise team, and in our most recent wave we found that despite the tech layoffs that have been all over the news, 31% of people are actually less worried about losing their job now versus a year ago. Can you tell me a little bit about what your team expects for the labor market in 2023? 

Sarah Wolfe: Well, the February jobs report was a whopper by any standard, 517,000 jobs and the unemployment rate hitting all time lows at 3.4%. However, I think it's important to put these numbers into a bit of context. We identified three temporary factors that boosted nonfarm payrolls in January and that we think are unlikely to persist in February. The first is weather. A warmer than usual January added about 130,000 jobs last month. The return of strike workers added 36,000 jobs and seasonal factors added 3 million jobs. Typically, we see the shedding of a lot of workers in January after the holidays, so leisure and hospitality, retail workers, transportation. But because we're dealing with significant labor shortages, and as a result companies are hoarding workers, we're seeing a lot fewer layoffs than we typically would given this time of the year and as a result, the seasonal factors are adding too many jobs right now. We expect the February print to be about 200,000, which is more in line with the trend that we had seen from July until December of 2022. We continue to expect job growth to slow this year, hitting a low of 50,000 jobs a month in mid 2023, pushing the unemployment rate up to about 3.9% by the end of this year. Michelle, you mentioned that you have an alphawise survey. Could you tell us a little bit more about what the survey’s telling you about consumer spending plans? 

Michelle Weaver: Sure. So on this wave of the survey, we asked people to think about major purchases that they're planning on making over the next three months. And we defined a major purchase like a vehicle, large appliance or vacation. And we found that about a quarter of people are considering shifting to a cheaper alternative, while a third are expecting to delay the purchase altogether. We also asked several questions on everyday purchases, and our survey indicates that consumers are planning to spend less on more discretionary categories. So that would include tech products, electronics, clothing, alcohol and home improvement. 

Sarah Wolfe: Michelle, that makes a lot of sense, and it's great to see when the hard data matches the soft data. We've done a lot of modeling work on how higher interest rates impact consumer spending, and we see a similar response in those categories. In particular, consumers tend to pull back on durable goods consumption, including home furnishing, electronics and appliances and motor vehicles. We haven't really talked about the services side yet. There was a big travel boom, post-COVID, do we expect this to continue this year? 

Michelle Weaver: Stocks exposed to travel did really well post-COVID as people were excited to get out there and travel again. Last year, we saw international travel restrictions lifted, making it a big year for vacations. And so there is some reversion likely here. And our survey showed that consumers are less positive on travel spending this year versus last year, with 34% of people expecting to spend less on travel and only 23% expecting to spend more. 

Sarah Wolfe: That's a pretty big step down in spending intentions on travel that your survey work shows. It also looks like in the economic data that the strongest part of the services recovery is behind us. We saw 10% nominal spending growth on services in 2021 and 2022. So, it's no wonder that this should decelerate in 2023 as the labor market cools and we return back to normal spending behavior. 

Michelle Weaver: Finally, Sarah, let's talk about inflation. Inflation is something I've definitely felt a lot as a consumer. For example, when I go to the grocery store, egg prices seem to be out of control, but when I look at my energy bill, things seem to be getting a little bit better. Can you tell us what's going on here and what you expect on inflation for the rest of the year? 

Sarah Wolfe: Unfortunately, we don't have a lot of transparency on the future of food prices right now, but we have seen pretty remarkable progress in other components of inflation that were weighing on household wallets in 2022. The first and foremost being energy inflation, which has returned back to its pre-COVID levels. We've also seen nice progress on goods inflation, where price levels have been coming off, in particular on new and used motor vehicles. And then we are seeing a slowing among services prices as well. In fact, headline PCE inflation has moderated from 7% this past summer to 5% today. And while this is great progress, the job is not done yet. We think inflation does reach 2.5% by the end of 2023, but this is going to require more aggressive action by the Fed. We now have two more 25 basis point hikes from the Fed in March and in May, reaching a peak rate of 5.25%. And we think they're going to have to keep rates on hold at their peak through the end of the year in order to make sure that inflation is getting where it needs to be. 

Michelle Weaver: Sarah, thanks for taking the time to talk. 

Sarah Wolfe: It was great speaking with you, Michelle. 

Michelle Weaver: And thanks for listening. If you enjoy Thoughts on the Market, please leave us a review on Apple Podcasts and share the podcast with a friend or colleague today.