A First Quarter Consumer Spending Resurgence

Scott Anderson
Chief Economist
Bank of the West

Never underestimate the U.S. consumers' willingness and ability to spend. January's U.S. consumer spending surge was even bigger than first reported, rising 2.0% month-over-month with a 1.5% monthly increase after adjusting for inflation. In addition, the February consumer spending numbers, released this morning, showed little concrete evidence of a U.S. consumer retreat either. Personal spending growth did decelerate to a 0.2% month-over-month pace with a 0.1% drop in real consumer spending last month, but after January's monster gain in spending, it virtually ensures a robust real consumer spending growth rate of around 4.2% annualized in the first quarter of this year. If realized, this would be the best quarterly consumer spending performance in more than a year. You have to go all the way back to the second quarter of 2021 to see a stronger real consumer spending growth rate.

Best Spending Performance In More Than A Year

What in the world was going on in January you ask? Pulling back the lens a bit, the January spending surge appears to have been a bit of a relief rally for the U.S. consumer in an otherwise prolonged period of moderation. Real personal spending has been negative in three of the last four months. The final estimate of fourth quarter GDP, released yesterday, revealed a downward revision in fourth quarter real consumer spending growth to just 1.0% from 1.4% as previously reported. So, consumers held back more than usual last quarter and more than they really had too given recent real disposable income trends.

Indeed, the fuel that sparked the January spending surge was the big jump in real disposable income growth in the fourth quarter and January of this year. Fourth quarter real disposable income growth surged at a 5.0% annualized growth rate even as real consumer spending contracted in November and December of last year. Then the 8.7% COLA adjustment to Social Security payments kicked-in in January, adding rocket fuel to an already accelerating real disposable income trend. This pushed real disposable income growth up to a sizzling and unsustainable 19% annualized pace in January.

Turbo Charged Real Disposable Income Growth

Historically, there is a very close relationship between real disposable income and consumer spending growth. We are not going to see a significant pull-back in consumer spending until we get a sustained drop and deceleration in real disposable income growth.

In fact, the income growth surge has been so good that households have been able to build back some of their personal savings in recent months to a respectable 4.6% in February from a low of 3.0% last September. Higher saving rates give more folks a cushion to ride out a temporary shortfall in income and keep spending through it.

Bottom-line, unless we get a significant softening in labor market conditions, I think we are going to continue to see a resilient consumer with elevated levels of inflation. We don't expect to see any material softening in labor market conditions in next week's March Employment Report. We forecast nonfarm payrolls will rise by around 250k with a steady unemployment rate of 3.6%. Robust and resilient job and income growth reinforces our view that the Fed will have to raise the Fed funds rate at least one more time in May before they have the luxury of pausing to see if the bank credit and monetary tightening unleashed so far will do the trick of putting the inflation genie back in the bottle.

Implications For the Economic Outlook

Given the strength and resilience in real consumer spending, disposable income, and U.S. job growth, we are increasing our first quarter GDP and consumer spending forecast to 2.0% and 4.2% respectively. We are also pushing more of the mild downturn in GDP growth we have been forecasting for this year into the third quarter. Last year we thought the second quarter of 2023 might be the weakest quarter, but given the unexpected strength of current economic conditions, a sharp downturn in economic growth in Q2 appears less likely even if we get significant additional tightening from the bank credit channel from the recent fallout from Silicon Valley Bank.

We are now penciling in a 1.3% decline in GDP for the second quarter and a 1.6% drop in the third quarter as real consumer spending stumbles to -0.4% in the second quarter and -0.8% in the third quarter. However, we will soon need to see outright net job losses, additional monetary tightening from the Fed, and much tighter financial conditions for this mild downturn forecast to actually materialize. Right now with a resilient consumer still intact, the evidence of an imminent economic downturn is pretty sparse.

With that said, the risk of at least a mild recession forming sometime in 2023 remains high. We have raised our probability of recession in 2023 to around 70% in the wake of the bank failures this month and the expected knock-on negative impacts it will have on the bank lending channel and economic growth. The boom-to-bust narrative we have been touting for the U.S. economy in 2023 from this historic Fed tightening cycle remains the most likely path ahead.

To learn more, check out this week's U.S. Outlook Report.


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