United States

Holiday spending should be robust (with an asterisk)

Pre-tariff spending expected to lift consumer holiday sales

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Favorable employment and income dynamics in the U.S. economy should result in a robust period of holiday spending this year that translates to a near 6.3 percent increase in sales, well above the 5.5 percent rise posted in 2017. We expect an increase to $735.5 billion from the $691.9 billion mark a year ago, a figure that does not include spending on restaurants, vacations and other leisure, automobile dealers or gasoline stations—all of which additionally imply a much stronger period ahead for the upcoming holiday season.

Moreover, we expect online sales to advance at a 15.4 percent pace to $159.71 billion, up from $138.4 billion in 2017. In our estimation, the combination of internet sales, a wealth effect garnered by rising stock prices, and the pulling forward of spending due to anticipated tariffs and higher retail prices on a wide array of consumer goods, portends stronger sales during the critical holiday season—strength that may be offset, however, by a slowdown next year after expected tariffs kick in.

The probability of increased spending to avoid higher tariff-driven prices could result in an additional one-half of 1 percent on holiday outlays: it is the primary catalyst for our optimistic forecast. Such a trend deserves a giant asterisk attached to it in the annals of holiday spending. In fact, there is some evidence that accelerated spending is already in train within the automotive industry and other manufacturers dependent on imported steel and aluminum—both early targets of increased duties—as consumers stock up on new cars, washers and other big-ticket items ahead of expected price boosts.

So why are we adding one-half of 1 percent to what would otherwise be a respectable 5.7 percent year-over-year gain? We expect the U.S. consumer to behave in an eminently rational manner in the face of the recent imposition of a 10 percent tax on 5,745 individual goods imported from China valued at $200 billion. Moreover, given a push by the current administration to boost that tax to 25 percent in January, as well as potentially impose an additional 25 percent tax on an unnamed number of goods valued at $267 billion, it is likely American consumers will pull a good bit of consumption and economic activity forward into the final quarter of 2018. When demand pulls forward, it usually results in a noticeable decline in overall consumption in the periods that follow and begs asking the question: are we understating the likely behavior by U.S. consumers conditioned to falling prices over the past three decades to a sudden price shock on core consumer goods?

The Brexit behavior precedent

In many respects, this pull-forward effect will roughly parallel behavior in the United Kingdom following the price shock that followed the June 2016 Brexit vote. As it became clear that a 19 percent devaluation in British sterling would result in a near-term increase in inflation (which jumped from 0.5 percent on a year-ago basis to 3 percent over following 18 months), rational behavior supported an increase in consumption before the price shock arrived. In many respects, the U.K. consumer experience following the Brexit vote provided a natural experiment on how an advanced wealthy consumer base responds to self-induced price shock. It is a solid benchmark to estimate U.S. spending, both in the third quarter of 2018 and in the holiday season, that drives spending over the final three months of the year.

So how did British consumers behave? They sustained an inflation-adjusted pace of spending at 3.1 percent in the two quarters following the policy shock, and then subsequently, began to pull back on consumption to a nadir near 1.1 percent, where it currently stands. While we do not anticipate a similar severe decline in U.S. consumption following the year-end holidays, disruptions to supply chains across both manufacturing and service sectors and the risk of further increases in import taxes, all point to a noticeable slowdown in the pace of consumption after an anticipated one to two quarters or more of robust outlays on goods identified as taxable imports.

The tailwinds behind the consumer sector are simply the best that they have been during the current business cycle. Job gains over the past six months have averaged 192,000 per month, and the overall labor supply has increased just under 0.8 percent, well above the long-term trend of 0.5 percent, with average hourly earnings on a year-ago basis at a cycle high of 2.9 percent. Consumer confidence stands at 138.4, a cyclical high, and the savings rate stands at 6.7 percent of personal income; meanwhile,  personal income growth is up 4.7 percent on a year-ago basis. Spending dynamics in the retail sector, on a three-month average annualized basis through August 2018, are up 6.8 percent, excluding autos (8.6 percent), outlays on gasoline (6 percent), building materials (8.9 percent), food service (5.2 percent), auto dealers (8.7 percent); excluding food, gasoline, building materials and auto dealers retail sales are up 5.4 percent using that metric. (This particular metric is used by the Bureau of Economic Analysis to estimate quarterly consumption.) So any way one slices it, spending in the household sector is on fire following an overall increase of 4 percent in the second quarter of this year. 

As always, the composition of good and services purchased during the holiday period is critical. A significant spending boost due to record equity prices will support an aggressive increase in purchases by the upper two quintiles of income earners via the wealth effect. At the current time, each 1 percent increase in wealth should likely result in an additional 1 percent increase in spending, and will be the primary driver of the holiday spending boost.

While the aforementioned tailwinds will support an improved spending picture among the middle strata and the lower two-income quintiles heading into the final months of 2018, given the relative demand elasticities in the face of rising prices, we anticipate that most consumers in those three quintiles will choose to make purchases around the holidays. By doing so, they will avoid the coming increase in prices associated with the most-recent tariffs imposed and those that will likely be put upon consumers in early 2019. 

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