The strong dollar, low interest rates and pent-up demand should drive after-tax growth in real consumer spending and a doubling of the rate of housing growth, according to Lombard Street Research.
Thursday’s 358-point plunge in the Dow Jones Industrial Average means that interest rates will remain low for the foreseeable future, and will continue to drive the coming household spending boom.
Lombard tracks personal income rising roughly by 4-4½ percent, with the gain split equally between growth in jobs and wages. At the current level of consumer spending, the falling trend of the personal savings rate from its winter high will add at least one percentage point to this growth. With core inflation at 1.25 percent, commodity prices still falling, and the strong dollar making imports cheaper, “real” (after-tax) consumer spending should rise.
Foreign governments around the world, desperate to revive growth, continue to engage in a currency war driven by quantitative easing and devaluations. As a result, the U.S. dollar is up 10 percent this year versus a basket of world currencies–its fastest rise in 40 years.
During the 10-year economic boom from mid-1997 through mid-2007, US “real” (after-inflation) consumer spending grew continuously, compounded at an annual rate of 3.47 percent, while overall inflation-adjusted annual growth of gross domestic product (GDP) averaged only 2.91 percent. That rate was about the same 3.50 percent compounded “real” rate of spending growth since President Ronald Reagan was elected in 1982 to 2007, according to the Federal Reserve Bank of St. Louis.
But from 2009 through 2014, “real” consumer spending only grew by about 1.9 percent annually, and GDP grew by a similar 2.1 percent. Both were the slowest five-year period of growth since the 1970s.
Lombard Street comments that the “first impact of the strong dollar is to lower prices. This is positive for now in an over-leveraged world short of consumer spending that needs more household income to avoid additional debt.” The strong dollar is also holding down interest rates and driving up housing affordability.
In the post-World War II period, U.S. housing starts ran at about 60 percent of the latest three-year average population growth. But that number plunged to 20 percent in the first year of the Obama administration, and only climbed slowly over the next five years.
But housing permits in the last two months averaged 49 percent of the latest three years’ average population growth, up from 39 percent in December. Housing starts in the period were at 48 percent versus 37 percent in December. According to Lombard, with “housing affordability still very high the expectation would be for starts and permits to be above average, not below it.”
Lombard suggests the “long-run drift towards single-person households might cause a gradually rising ratio of starts to incremental population.” It adds that the “natural level” of housing starts should actually be higher than the 52-year average for housing starts of 60.7 percent.
Although affordability is not the only factor affecting housing activity, the National Association of Homebuilders Index and affordability tended to move together before the Financial Crisis. But fear and deep structural changes in the economy broke that cycle over the last six years.
The robust revival of consumer demand over the last few months has paved the way for what Lombard calls a return to “some degree of normalcy” in housing construction. With a housing construction deficit of about 6 million housing starts since 2008, and continuing high affordability, the housing starts could rise at a historically screaming 8-8.5 percent.