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- [00:01]
Arunima Sinha
Welcome to Thoughts on the Market. I'm Arinima Sinha from Morgan Stanley's global and U.S. economics team. It's been almost three months since President Trump took office and today we want to take the pulse of the US consumer. It's Tuesday, April 1st at 10:00am in New York. We recently lowered our forecasts for nominal consumption spending in 20, 25 and 26 on the back of increased policy uncertainty and we now see bigger downside risks to consumption. To understand what's happening, I'm joined by my colleagues James Egan, Morgan Stanley's co head of US Securitized Products Research, and Heather Berger from the US Economics team. Heather, I want to come to you first. Could you walk us through our view for the year in the context of where consumption spending is now?
- [00:52]
Heather Berger
What we've seen is that through the end of last year, consumer spending growth actually held up pretty well. We saw that nominal and real spending growth both outpaced the pre Covid averages in 2024 and there was actually strength into the end of the year as well. So far this year we have seen that there has been more weakness in terms of consumer sentiment as well as some of the spending data has been a bit weaker, a bit sooner than expected. What's really been supporting consumers and supported spending last year has been continued growth in labor income as well as significant accumulation of we which has really supported high income consumers. Heading into this year we did expect that consumer spending growth would slow largely because of the impacts of tariffs and immigration, and we did lower our spending forecast from where we had them at the end of last year. So far we do think that most of the weakness has been in the soft data in terms of sentiment. But we still do expect that these policy changes will result in further slowing throughout the year. But even though the consumer at an aggregate standpoint has been holding up the there has definitely been bifurcation under the surface over the past few years with lower income and middle income consumers in many cases feeling more stretched. And so Jim, we've definitely seen some of that play out in the delinquency data. Can you tell us a bit about what you've seen there?
- [02:05]
James Egan
Right Heather, as you're referring to, delinquencies are climbing, but we do think you have to look under the hood a little bit here. Let's start with the auto space. Delinquency increases started with lower credit score lower income consumers, but recently we've seen delinquencies start to rise for prime auto loans as well. If you look at the mortgage space and given how tight lending standards have remained over the course of the past 15 to 17 years since the great financial crisis, we're talking about a prime consumer there. Delinquencies are rising, but they're rising in smaller corners of the market. For instance, the non qualified mortgage space, which makes up roughly 1 to 3% of annual originations. And we think it's important to note that these increases aren't uniform across product types. When we look at unsecured consumer products or credit cards, we aren't seeing the same amount of increase in delinquencies that we've noted in the auto space. On top of that, if we do look at autos and also the mortgage space, delinquencies are increasing. And while defaults and losses are higher too, they aren't increasing at the same rate that the delinquency climbs would suggest that means that the consumer isn't rolling into default at the same rate that they have historically. When you put it all together, this increase in delinquencies, it is definitely worth paying attention to and we are paying close attention here. However, from the perspective of securitized products, it's not necessarily something that has us moving all the way towards cautious just yet.
- [03:27]
Heather Berger
So delinquencies have risen, but not necessarily a systemic risk yet. That said, we're still expecting consumer spending growth to slow this year because of some of the policy impacts that I mentioned. So Arunima, can you tell us a bit about architect our expectations around tariffs and what that means for the consumer moving forward?
- [03:45]
Arunima Sinha
We looked at the 2018-19 experience to think about how it could matter for consumers today. One aspect of tariffs is that consumers may be able to engage in expenditure switching. So you try to buy a similar product which is at a lower cost, but with broader tariff uncertainty that may be less feasible. Using the 2018-19 experience, a Fed study found that different cohorts of consumers are differentially exposed to tariffs. We already know that the lower income cohorts have faced higher inflation rates due to just the different types of expenditures shares that they have. In our view, the effects on consumer spending from tariffs could be even more exacerbated this time around because a lot of the changes in import shares that had to occur have already been done.
- [04:38]
Heather Berger
And what about some of the impacts on the wealth and immigration fronts?
- [04:41]
Arunima Sinha
To think about the wealth effects for the US consumer, we have to think about how wealth has been changing. And so over the post Covid phase between 2020 and 2024, we had a tremendous increase in net worth for US households, it went up by more than $50 trillion. That's more than twice the size of the US economy. A lot of that increase accrued to the top 20% of the income cohorts. You now have an income cohort that is more exposed to the equity markets than they were in the past. If the downdrafts in the equity markets are perceived to be more permanent by this particular income cohort, they could begin to pull back on spending that's going to permeate through the economy. And then to think about immigration, we do need to think about which effects are going to dominate. Is it going to be the supply effects or the demand effects? We think that it'll be the supply effects from reduced immigration that are going to matter just given the characteristics of the immigrants who are coming in. They're younger, they have higher rates of labor force participation and employment, but they typically are in the lower to middle income cohorts. So that means when you reduce the size of the labor force, as the growth of the labor force moderates, it begins to moderate the labor market income, which is the primary driver of consumption for the lower and middle income cohorts. So, Heather, could you walk us through what the impact could be on the consumer from some of the changes in fiscal policy that are being talked about.
- [06:19]
Heather Berger
In our base case? On the fiscal side, we expect that the Tax Cuts and Jobs act will be extended by the end of this year and there may be a few add ons, but we don't really expect any meaningful additional spending cuts. If we were to get more spending cuts either from the budget or from doge, we think that this poses further downside risk to consumption growth and to GDP growth, especially if these cuts are in areas with larger multipliers such as entitlement programs similar to tariffs. If we did make cuts to transfer payments, this would likely impact lower income consumers more. I will say that one positive on the fiscal front is that so far the average size of tax refunds and, and the total dollar amount of tax refunds has been trending high relative to recent years. So this could provide some incremental boost to incomes in the near term.
- [07:08]
Arunima Sinha
To round off Jim, we need to talk about the housing market. What do you think is going to happen to house prices this year?
- [07:15]
James Egan
Okay, so to think about the trajectory for home prices in the United States this year, we have to take a number of things into account. One of the things that we've said on this podcast many times, affordability in the US Housing market is stretched. One of the reasons for that. We're not going to go into the lock in effect here, but the inventory of homes available for sale is very low. The three of us also just co authored a note talking about tariffs. A lot of uncertainty there, but when we think about the materials that go into construction, a large percentage of them, we estimated about 24% are imported. So while there is some uncertainty on that front, that should provide some upward pressure from a pricing perspective. Let's say home prices were to go up 5%. You would need mortgage rates to come down roughly 50 basis points to keep affordability flat. All else equal, this is also happening at a time like More of these primary effects are in the new home market, not the existing market. New home sales are making up their largest share of monthly transaction volumes since 2006. We also continue to subscribe to the fact that we're under built in the US Housing market. Builder sentiment has been soft the past two months. Single unit housing starts. They've effectively been muddling along for the past eight months. At this point, conservatively, we think we're 1.1 million units shy of where we need to be. That's going to also provide upward pressure to the US Housing market. We don't think with this affordability challenge that you're going to see weaker sales volumes. From here, we think turnover in the US Housing market is effectively at its lows right now, and purchase applications, Those are up roughly 5% in both February and February and March. All of this combined we think is going to introduce a little bit of upward pressure to home prices. We're moving closer towards our bull case from our 2025 outlook. That bull case was plus 5% year over year home price growth. Maybe not all the way there, but sustained growth in US Home prices.
- [09:03]
Arunima Sinha
Jim and Heather, thanks for taking the time to talk about the US Consumer and the different policy catalysts that'll matter and to our listeners, thanks for listening. If you enjoy thoughts on the market, please leave us a review wherever you listen and share the podcast with a friend or colleague today. The preceding content is informational only and based on information available when created. It is not an offer or solicitation, nor is it tax or legal advice. It does not consider your financial circumstances and objectives and may not be suitable for.