In developed countries, economic growth is mainly driven by household consumption. On average, household spending accounts for 60% of Gross Domestic Product (see Fig. 2). In the United States, it has been rising steadily since the Second World War and the advent of the consumer society, reaching 71% of GDP (see Fig. 3). In the Eurozone, the phenomenon is less pronounced, and the trend is downward, but the ratio of consumption to GDP still reaches 52%.
As the consumer is the main driver of economic activity, investors pay particular attention to the level f household confidence. Household confidence depends mainly on labour income, developments in savings and financial markets, and credit conditions.
Usually, as long as job creation is strong, investors have little to worry about in the event of a recession. Yet the labour market is a lagging indicator of the business cycle. It is only when companies have seen that their order books are empty, that they have stockpiled, and that they have stopped investing in new machinery, that they lay off some of their staff. By the time employment contracts, it is already too late to worry: the recession is in place. This time, not only are companies late in reducing their workforces, but they have over-hired (see Fig. 4).
For several quarters now, order books have been weakening (see Fig. 5), capacity utilisation rate has been falling, capital expenditures have been declining (see Fig. 6), but companies are still hiring. In the US, employment growth is peaking at 3.2% per year while output is stagnating at 0.9%. The corollary of this situation is that productivity has never fallen so much: -2.3% (see Fig. 7). This phenomenon will reduce margins and force companies to lay off more than usual in order to get back into balance.
Recent labour market dynamics have seen wages rise by 4.4% in the US. This increase in income could have been a boon to households, but this was without considering the even more rapid increase in inflation for goods and services. Unlike in the 1970s, when the previous major inflation shock occurred, the labour market is not tight enough today for households to hope to negotiate wage increases to offset rising prices. In the end, consumers have lost 2.4% of their purchasing power (see Fig. 8).
Household savings had grown rapidly during the periods of lockdown, when governments provided fiscal packages. In the US and Europe, 80% of the remaining excess savings are held by the richest households. It is therefore unlikely to be spent. Instead, it will probably remain invested in the financial markets, at the risk of evaporating if the latter fall further.
Changes in mortgage rates also have a major impact on the ability of households to spend. As their interest burden increases, their ability to consume decreases. A US household with a 30-year mortgage was paying $1,600 per month in 2021. This amount has risen to USD 2,600 in 2023 (see Fig. 9). The difference will not be saved or spent. Worse still, as real estate prices contract, households will see their wealth shrink. They will increase their precautionary savings and curb their consumption even more.
To make ends meet, some households have no choice but to take on consumer credit. In a survey conducted at the end of October 2022, 7 out of 10 Americans said they were worried about their finances over the next 12 months. Their number one concern (31%) is having to take on more debt to meet necessities, with 19% having already done so in 2022.
Despite the strength of job creation, it is therefore no surprise that consumer confidence is eroding (see Chart of the Week & Fig. 10). In both the US and Europe, it hit an all-time low in 2022. In recent months, it has rebounded but remains at a depressed level, consistent with a contraction in private consumption. The loss of purchasing power, the fall in savings, the rise in interest charges and the future wave of layoffs are forcing households to be careful. The growth of retail sales, both in value and volume terms, reflects the situation perfectly. While nominal retail sales have risen by 6.4% over the past 12 months, real retail sales have stagnated (see Fig. 11), indicating that households have been spending more but consuming the same. Similarly, in the Eurozone, major purchases are becoming increasingly rare (see Fig. 12). Priority is given to basic needs: food, health care and debt repayment.
Given the state of financial health of households and their loss of confidence, companies selling basic goods and services, consumer staples and health care, will be more resilient than those selling discretionary items (see Fig. 13).