Kristina Hooper, CFP, CAIA, CIMA, ChFC, is US head of investment and client strategies for Allianz Global Investors. She has a B.A. from Wellesley College, a J.D. from Pace Law and an M.B.A. in finance from NYU, where she was a teaching fellow in macroeconomics.
For gloomy consumers, it’s all in their heads.
The psychological impact of the government shutdown is probably a lot greater than its economic impact. While the crisis in Washington was relatively short-lived, consumer confidence has plummeted since the budget battles first gripped the nation a month ago. And it may not bounce back so easily.
Still, it’s important to draw a distinction between what consumers are feeling and what’s on their balance sheets. Despite short-term uncertainty and heightened market volatility, US consumers are reducing revolving debt and taking advantage of lower interest rates.
Focus on Fundamentals
Now that the shutdown is over, it’s important that investors refocus on fundamentals, which have largely been overlooked during the latest D.C. drama. The reason the consumer is critical is because consumer spending makes up a substantial portion of the country’s GDP. In terms of fallout, consumer sentiment seems to be the biggest victim of the government shutdown. Indeed, the October Thomson Reuters/University of Michigan consumer sentiment index (mid-month reading) came in at 73.2, well below expectations and below the previous reading. And Bloomberg’s consumer comfort index showed that consumer confidence continued its decline this week, with ratings of the US economy at their lowest level in a year, and the overall index at nearly a nine-month low.
Many market watchers are assuming that the consumer will quickly recover because the drop in sentiment was due to the shutdown. But a speedy rebound in sentiment may not be a sure thing. While we saw sharp reversals in consumer confidence after the two previous shutdowns, sentiment heading into those periods was more positive (the consumer confidence index was at -14 in 1995-96 compared to -28.1 today) and the economy was far less fragile. Take a look at the lackluster September employment report, which was delayed for three weeks due to the shutdown. It details the job situation before the actual closure, suggesting that we were already seeing signs of weakness when the dust-up in D.C. unfolded.
||The unemployment rate dropped to 7.2% from 7.3%. However, details about the decline in the unemployment rate underscore the view shared by many FOMC members that it’s a flawed measure of labor-market strength. Indeed, a low labor force participation rate is a significant contributor to lower unemployment.
||Non-farm payrolls came in at 148,000, well below consensus expectations. And the private sector added only 126,000 jobs, well below where they’ve been in previous months.
Now, if the jobs recovery is not currently strong enough to power the consumer, then what will it take? The answer may be housing. Research by Case, Quigley and Shiller shows that higher home prices typically create a “wealth effect” that’s more powerful than rising stock prices. If homeowners believe their houses are worth more, then they’re increasingly likely to spend more. Of course, for the housing recovery to continue, we need to see low mortgage rates.
More Mortgage QE
Consider the research paper presented at Jackson Hole by Arvind Krishnamurthy on unconventional monetary policy. The key finding in this paper was that the purchase of mortgage-backed securities (MBS) has depressed mortgage yields more than the purchase of Treasuries. In other words, mortgage QE is more economically impactful. That could explain why we saw a slowdown in the housing recovery this summer after “taper talk” pushed mortgage rates higher. And it’s no surprise that, since the FOMC’s September decision to postpone tapering, mortgage rates fell—although not to the level seen earlier this year. Lower mortgage rates are a clear driver of home sales and home prices.
Given the role housing plays in consumer behavior, don’t be surprised if the Fed, when it decides to pare its bond purchases, leaves MBS QE alone and focuses on tapering government bond purchases, as some FOMC members have advocated. And while strict lending standards offset some of the positive impact of loose monetary policy, they may not be a deal breaker. That’s because we’re seeing more institutional home buyers (defined as persons or institutions who have purchased 10 or more residential properties in the last 12 months) enter the market; in fact, they comprised 14% of all residential sales in September, significantly higher than what we’ve seen in recent years. In fact, institutional investment in residential properties is at its highest level since RealtyTrac started tracking those purchases in January 2011.
Most of all, it’s important to look at the big picture. Despite short-term risks, the long-term outlook for consumers remains positive. As consumers deleverage and reduce their overall debt-servicing costs, they’ll be in a better position to act on their improved sentiment when it kicks in. It’s not just about confidence. It’s about discipline too.
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