Arunima Sinha: Welcome to Thoughts on the Market. I’m Arunima 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 U.S. consumer.
It’s Tuesday, April 1st, at 10am in New York.
We recently lowered our forecasts for nominal consumption spending in 2025 and [20]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 U.S Securitized Products Research, and Heather Berger from the U.S. 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?
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 wealth, 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, 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?
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 per cent 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.
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 our expectations around tariffs and what that means for the consumer moving forward?
Arunima SinhaWe looked at the 2018-19 experience to think about how it could matter for consumers today. And so, at The 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 phased higher inflation rates due to just the different types of expenditures shares that they have. And in our view, the effects on consumer spending from tariffs could be even more exacerbated this time round because a lot of the changes in import shares that had to occur have already been done.
Heather Berger: And what about some of the impacts on the wealth and immigration fronts?
Arunima Sinha: To think about the wealth effects for the U.S. 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 U.S. households. It went up by more than $50 trillion. That's more than twice the size of the U.S. economy.
A lot of that increase accrued to the top 20 per cent 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?
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 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.
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?
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 U.S. housing market is stretched. One of the reasons for that, we're not gonna 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 per cent – 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 per cent, 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 underbuilt in the U.S. 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 U.S. 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 U.S. housing market is effectively at its lows right now. And purchase applications, those are up roughly 5 per cent in both 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 per cent year-over-year home price growth. Maybe not all the way there, but sustained growth in U.S. home prices.
Arunima Sinha: Jim and Heather, thanks for taking the time to talk about the U.S. 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.
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