Consumer spending is drying up and the market is not ready for it

(Bloomberg) — A key source of U.S. economic growth this year, consumer spending, is showing signs of losing steam even before the round of Federal Reserve rate hikes begins on Wednesday.

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Credit card data shows spending in May was just 10% higher than the same month last year, according to a Barclays report this week. For the rest of 2021, that monthly spending growth averaged more than 20%.

That growth slowdown, combined with weakening home sales and declining wage growth, would mean that monetary tightening is already hitting the economy hard. The Fed may be able to tighten less aggressively in July, according to Barclays, which forecasts a rate hike of just half a percentage point next month. Rate markets indicate a strong possibility of a three-quarter percentage point increase.

Equity and corporate bond markets do not reflect the risk of a weakened consumer, Barclays strategists including Ajay Rajadhyaksha, Ryan Preclaw and Hale Holden wrote in a separate note on Tuesday. The slowdown in consumer spending growth underscores how difficult the Fed’s job is as it seeks to contain inflation that is at its highest level in four decades, while trying to prevent the economy from sliding into recession.

The weakening only started in the last four to six weeks, but was visible among high- and low-income consumers, the strategists said, based on a sample of credit card data from Barclays. And it’s consistent with a report on Wednesday that showed retail purchases fell 0.3% in May from a month earlier, the first drop this year.

“Like Atlas with the world on its shoulders, the consumer has been supporting the US economy and, to a large extent, the world throughout the year,” the strategists wrote. “But that could be about to change.”

target, walmart

Consumer spending accounts for about two-thirds of US economic activity and, in the first quarter, was the segment that performed relatively well, even as government spending fell and corporate investment lagged. But there are signs that Americans are becoming less willing to spend and are generally weaker.

Inflation is taking a bigger toll on incomes, forcing Americans to spend more of their spending on staples like food and gas, leaving less room for discretionary purchases. That is leading to higher inventories at Walmart Inc. and Target Corp., and also pushed the savings rate in April to the lowest level since 2008.

Given these declines, full-year earnings estimates for consumer discretionary stocks are likely to fall between 2.5% and 5% on Wall Street, Barclays strategists wrote. Those kinds of declines have typically resulted in these stocks performing more than 2 percentage points worse than the broader market.

For high-grade corporate bonds, risk premiums hovered around 1.4 percentage points on Wednesday, according to data from the Bloomberg index. They are likely to hit 1.5 percentage points by the end of the year, Barclays strategists said.

nothing is immune

The slowdown in spending growth appears to be happening in both goods and services, Barclays wrote. Earlier this year, many strategists expected consumers to increase vacation travel and go to restaurants more often. While that was true for most of the year, in the last six weeks spending on services grew by just 15% over the same period in 2021, compared to about 30% earlier this year.

And more subprime borrowers are falling behind on their auto loans, according to S&P Global Ratings’ tracking of consumer debt-backed bonds. Delinquency rates rose to 3.82% in April, returning to 2019 levels, compared with 2.49% a year earlier, the ratings firm said in a report on Tuesday.

These figures coincide with a report last week that showed consumer confidence plummeted in early June to its lowest level on record, according to the University of Michigan confidence index. The report aligns with the argument that US consumers may be starting to pull back, Barclays wrote.

Borrowing costs are rising across the economy as the Fed tries to rein in inflation, which hovers around 8.6% a year. The Fed said it would raise short-term rates by 0.75 percentage point on Wednesday, the biggest increase since 1994, and expects more hikes this year as it tries to bring inflation closer to its 2% target.

job cuts

While the US job market is still strong, a June 2 report from relocation firm Challenger, Gray & Christmas said May saw an increase in announcements of job cuts in some industries, including construction. and technology. Sectors that shed jobs tend to be more sensitive to rates or the struggling stock market.

Coinbase Global Inc., the largest US digital asset trading platform, said it will cut about 18% of its workforce on Tuesday, citing the slump in cryptocurrencies and worsening economic conditions. Real estate brokers Compass Inc. and Redfin Corp. said they are laying off workers as mortgage rates rise and home sales fall.

“An entire army of appraisers, loan originators, title company workers — hundreds of thousands involved in the mortgage refinancing machinery — are vulnerable,” the Barclays strategists wrote.

Bond investors are increasingly concerned about spending and layoffs, demanding higher interest payments when they buy notes backed by consumer loans. The lowest-rated portion of a bond from auto lender Exeter Finance, backed by subprime auto loans, sold at a yield of 9.545% this week, according to data compiled by Bloomberg News.

That may be the highest yield for such a security since the financial crisis, John Kerschner, head of US securitized products at Janus Henderson Investors, said in a phone interview. The high level also reflects broader market turmoil this week, investors said.

The Fed has no choice but to tighten further now, which will likely only further reduce consumer spending.

“The Fed is in a very difficult situation with inflation,” Cristian deRitis, deputy chief economist at Moody’s Analytics Inc, said in a telephone interview. “Consumers are also facing multiple shocks from rising food and gasoline prices. Rising interest rates only adds to the stress.”

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