Both Australian and US consumer confidence surveys are wallowing at very depressed levels.
However, both economies continue to register multi decade lows in unemployment, while consumer spending has, so far, remained relatively resilient. So, why is sentiment so gloomy relative to actual spending patterns?
We would attribute a large portion of the slump in consumer sentiment to a combination of the surge in consumer price inflation, combined with the sharp rise in interest rates seen over the past year. From this perspective, it is interesting that Australian consumer sentiment is currently weaker (relative to the historical trend) than US consumer sentiment. This more marked weakness in sentiment is despite a less aggressive interest rate cycle playing out in Australia over the past year.
In our view, this reflects two related factors. Australia’s higher level of household sensitivity to variable interest rates (the US mortgage market is based on very long-term fixed rate mortgages), as well as Australia’s much higher level of household debt (see figure 4). This inherent sensitivity to the short-term policy rate in part explains why the Reserve Bank of Australia (RBA) has been more reluctant to raise rates aggressively relative to its US counterpart.
The Sentiment versus Spending Gap
The fact both economies continue to show a degree of spending resilience is interesting in light of such depressed levels of consumer confidence.
The divergence is particularly stark for Australia, with confidence on a par with the GFC and the brief but sharp “Covid recession” of 2020.
We believe two factors have buoyed consumption versus sentiment and will provide some degree of support over the balance of this calendar year at least.
Firstly, the robust state of the labour market. Both the US and Australian economies are essentially at, or beyond, full employment. This is undoubtedly supporting spending despite the consumer being “unhappy” with price and interest rate pressures.
Secondly, both economies have yet to exhaust the large savings balances built up in the pandemic.
Both these supportive variables are likely to gradually wane over the course of the next 12 months but should cushion the extent of the consumer slowdown.
Closing the Gap with Softer Spending
We expect that consumer spending will soften, but a relatively mild rise in unemployment and large excess savings pools will help soften the blow.
Despite less sensitivity to interest rates, the US savings pool appears smaller (as a percentage of GDP) and is therefore likely to be exhausted earlier than in the case of Australia. Even in Australia’s case, the apparently very large savings buffer likely overstates the degree of cushion, given the apparent skew of excess savings to wealthy older households. However, on the positive side, strong migration flows are likely to support aggregate Australian consumer spending to some degree.
So, our base case is for relatively more consumer resilience in Australia than in the US over the coming year, although we expect a significant consumer slowdown in both economies.
One clear trend already beginning to play out within both economies is the distinction between goods relative to services spending.
“Goods” Spending Recession Likely
Goods spending is beginning to downshift from a very elevated level. Above trend goods spending was due to a pandemic induced shift in spending patterns aided by huge government transfer payments. In contrast, services spending slumped to depressed levels during the pandemic but has been recovering rapidly of late.
So, against a broad trend of a softer consumer we expect the story of a goods spending recession to come sharply into focus in the near term. We continue to avoid exposure to most goods retailers in our equity portfolios and, more broadly, we are focused on earnings resilience over the coming year. Services spending will likely take longer to slow, and the slowdown will likely be a lot less dramatic.
Australia versus the US
Whether the consumer spending slump will be enough to cause a domestic or US GDP recession is open to debate. We believe Australia can avoid a recession due to a combination of excess savings, strong migration flows and a buoyant position in terms of trade.
These drivers are less obvious in the US, so we feel recession risks are higher, though healthy household balance sheets, a degree of residual savings and our expectation of a limited rise in unemployment suggest the US downturn can still be relatively mild, historically speaking. The prospect of lower inflation and lower interest rates over the coming year is also likely to ease pressure on the US consumer. The business sector (via capex and employment plans) may well hold the key in gauging the extent of the economic slowdown, with (business) credit conditions and financial stability likely to be key swing factors in determining the extent of the downturn over and above a softening consumer. We continue to watch lending conditions and the employment market closely.
Written by
David Cassidy, Head of Investment Strategy
David is one of Australia’s leading investment strategists.
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