Steven Andrew looks across the pond again to analyse the amount of mortgage refinancing the US consumer is undertaking
Softer than expected US employment market data released for January reinforces our opinion that the impetus behind domestic consumption growth will be only mediocre in 2005 - especially in the first half of the year. But as ever, we should remain wary of the proven capacity of the US consumer to exceed our expectations.
In that regard, as we have recently discussed, increased equity dividend payouts may play some part in boosting buying power; though we can find no clear relationship between personal consumption growth and changes in the personal sector’s income on assets.
Mortgage refinancing
A further and more significant source of additional funds is mortgage refinancing. This route has been clearly utilised to great effect over the past two years. With the proceeds of refinancing (specifically ‘cash-out’ mortgages) – of which Chairman Greenspan has been quoted as considering about 50 per cent to be spent – reaching a high of 4.5 per cent of household income at the peak in Q3 2003.
There is a very good relationship between changes at the long end of the yield curve (represented here as the 30-year fixed mortgage rate) and changes in mortgage refinancing applications, with consumers responding almost on a week-by-week basis to changes in the cost of borrowing.
But the crucial factor here is that the interest rate has typically needed to break new lows to spark a meaningful bout of refinancing. Thirty-year mortgage rates, at 5.48 per cent, are currently just 14 basis points away from reaching their March 2004 lows of 5.34 per cent which saw refinancing rise to more than double its current levels. While breaching this mark would be reason enough to expect a decent boost to borrowing, if rates were to decline further, towards the June 2003 low of 4.99 per cent, then we would likely see a much more significant lift to borrowing – and spending – calling into question the notion that consumption will step back towards income growth.
Future income growth
Of course time is already running out for Q1. Unless fresh stimulus from borrowing is delivered very soon, it remains our view that personal consumption growth will decelerate (by a fair bit more than the market expects), thanks to sluggish income growth. But we’ll be keeping a close eye on lending data in the coming weeks to assess the risk that, yet again, the mighty US consumer is set to go back to relying on future income growth to spend more now.
Steven Andrew is an economist at F&C Asset Management plc
Key developments
UK economics newsflow has picked up again, reinforcing our view that the near-term prospect for markets will be to price-in a further tightening in UK interest rates. That said, our conviction remains high that the current rate of 4.75 per cent will be the peak for the year, with decelerating domestic demand leading to a small adjustment to lower interest rates in H2. Industrial output data released this week surprised on the upside (for a change), boosting the three-month rolling GDP figure (calculated by the National Institute of Economic and Social Research) to 0.8 per cent in January from an upward-revised 0.7 per cent in December – this was initially stated as 0.4 per cent).
President Bush released details of his Administration’s 2006 Budget this week, pledging to address the nation’s $430 billion (3.5 per cent of GDP) fiscal deficit by imposing strict controls on discretionary government spending. Excluding defence, government spending is tabled to decline for the first time since Ronald Reagan was in power. Treasury Secretary Jon Snow mounted a robust defence of the decision not to raise money from new taxes; indeed, the Administration’s two big tax cuts of the past three years have now been made permanent (at a cost of $500 billion between 2006 and 2015).
There are two key points which emerge from this budget: first, the growth assumptions are rather optimistic, requiring GDP growth in excess of 3 per cent every year through to 2009. The US economy has only managed such a feat once in the past fifty years – from 1983 to 1989. Second, the budget figures totally ignore any ongoing costs associated with operations in Iraq and Afghanistan, as well as the cost of the President's social security reform plan. These are quite sizeable and unpredictable chunks of spending to be missing from the budget.
