Morgan Stanley
  • Thoughts on the Market Podcast
  • Apr 6, 2021

The Return of the Services Sector?

With Ellen Zentner and Sarah Wolfe


Ellen Zentner: Welcome to Thoughts on the Market. I'm Ellen Zentner, Chief U.S. Economist for Morgan Stanley Research.

Sarah Wolfe: And I'm Sarah Wolfe, also on Morgan Stanley's U.S. Economics team.

Ellen Zentner :And on this episode of the podcast, we'll be talking about the budding return to normal among the most covid sensitive areas of the U.S. economy. It's Tuesday, April 6th, at 8:00 a.m. in New York.

Ellen Zentner: Sarah, we've talked a lot on the podcast about how resilient the economy has been over the past year with perhaps a faster recovery than many would have thought. But given your focus on the U.S. consumer, I wanted to have you on today to talk a little bit about the green shoots that we're seeing in the services sector, like dining, air travel, hotels. Maybe start off with what you're seeing from the February and March data.

Sarah Wolfe: Over the last year we've largely had a good spending led recovery, but now it's finally broadening out into a covid sensitive sector recovery. I would say that if you look at the February/March data, we're seeing a rebound all connected, but in three categories we're looking at. One is actual engagement and activity. So we're seeing dining, air travel and hotels relative to pre covid levels increasing by about 20 percentage points just in the last month.

Sarah Wolfe: The second way we're seeing it is in consumer confidence data. In March, The Conference Board Consumer Confidence survey jumped by nearly 20 points to a pre covid high, bolstered by stronger income, business and employment expectations. And we also saw in the survey that there's increased spending intentions for homes, autos and big-ticket items. So this will really be a recovery with many winners and not just the service sector. And then the third place that we're seeing the turn in data this past month is in the labor market. So in February and March, we saw leisure and hospitality sector jobs increased by 660,000 just in the past two months. And that's after we saw nearly no job gains in this sector in the year prior.

Sarah Wolfe: So this still leaves a sector short by three million jobs, but it is a notable improvement. And what we're seeing is that there's increased activity and engagement in in-person activities through the hotel occupancy and dining out data. It's being reflected in confidence. And as a result, businesses are finally bringing back the service sector jobs, which is so important because 84% of US payroll is in the services industry.

Ellen Zentner: So certainly, you know, it feels like we could have the makings of a virtuous cycle here. But as you noted, there's a long way to go. But when I think about, the metrics that we're seeing in the labor market today, right? It's a 6.2% unemployment average in the first quarter was also underpinned by a pickup in labor force participation, which is what we really want to see. People still attached to the labor market and coming back, right? As the economy is reopening, we've already seen nearly a million print on jobs in this latest March employment report. And so it certainly looks like the labor market indicators are running ahead of even our expectations.

Ellen Zentner: And I think that's really important here because, you know, we talk about oftentimes on our team, in our notes, how important it is that labor income comes back, right? Because you've written about personal income overall having returned to pre covid levels, but a lot of that being helped by unemployment benefits, government transfers. Now we'll have labor income, which will be reaching back toward pre covid levels because of bringing all those jobs back. And so I bring that up because you track very closely what's coming in to bank accounts from the unemployment benefits, from the stimulus checks, how the tax refund season is tracking. And so, walk us through some of the data points that we're seeing there, because the hope is that as those payments start to recede, that labor income is replacing that.

Sarah Wolfe: So I like to think of the major income streams falling into four buckets. We have wage and salary income, which is just reaching its pre covid level now, but has been running below it because of the labor market recovery. We've had economic impact payments, so the $1200 checks from the CARES Act in April 2020, the $600 checks this past January and then the $1400 checks being distributed now. Then we're getting unemployment insurance benefits and the supplement. So in the CARES Act we had $600 weekly supplement and now we have $300 weekly supplement. So that supporting them in particular the most vulnerable households that have been out of work. And then the fourth one and which is really important right now, are tax refunds.

Sarah Wolfe: So looking at these four main streams of income, we're particularly focused right now on wage and salary income. The fiscal stimulus impulse to households is going to fade. We're not going to get more economic impact payments and unemployment insurance benefits, the $300 supplement, are set to expire this September. So in order to make a seamless transition for households, we really need this labor market recovery and boost to wage and salary income, which we are expecting to come, robustly in the coming months as we bring back a lot of these jobs. There's still a lot of room to run in the labor market, in particular. Roughly two million individuals are classified as temporary layoff. So that's a lot of jobs that are ready to come back in as we accelerate the reopening, and that will all contribute to the transition away from stimulus income and towards labor market income.

Ellen Zentner: But, Sarah, there's something else that you've been looking at here as well, and that's the excess savings. So we're getting a lot of income, be it from the labor market, but mostly from government transfers, still. And it's coming at a time when we can't really spend all of it in the way that we want to. And so it's just building up in folk's bank accounts. And you've been tracking that as excess savings. When we think about what the consumer is doing after this year, it's easy to see them spending more as the economy is opening up this year. But does this excess savings play some kind of role when we look further out?

Sarah Wolfe: So before covid say the savings rate, so how much you saved as a percent of disposable income, was in about 7.5%. And during covid that skyrocketed to 15%, 20%, getting above 20% at certain points as well. And that is because of all the stimulus and the lockdown. And so in 2020, we estimate that $1.5T in excess savings, was accumulated. And then just looking into 2021, we expect another $700B to build up in the first and second quarters as we continue to get more stimulus and spending slowly recovers.

Sarah Wolfe: So that leaves us with about $2.2T in excess savings built up over two years. And as the economy reopens, some of that is going to come back in and fuel the recovery. A lot of this, though, is not being viewed as active income anymore. So while we place about a 25% marginal propensity to consume the excess savings, but spread out over the next two years. It's going to take time for people to spend down the savings and for the economy to fully reopen, but even just a 25% marginal propensity to consume, $2.2T goes a very long way in terms of consumer spending. And for this reason, we've been also above consensus on our consumer spending outlook because it really provides a strong impulse to the economy.

Sarah Wolfe: I think one interesting point is that with services in particular, you know, you're not going to be able to get six haircuts this year because you missed a couple last year. You don't double up on services spending, but you might spend a bit more than you would have before. What we actually saw in a recent AlphaWise survey, which is our internal data and survey team at Morgan Stanley, is that people want to take three to four vacations after covid compared to one last year. And even if they're only going to take one to two, they're planning to spend more on their vacations. So there's this very strong willingness to return to pre covid spending and very strong buying power among U.S. households right now.

Ellen Zentner: So I think that those AlphaWise surveys of the consumer, and U.S. households for us have been very important in terms of how we track our confidence that our consumer spending calls will be right. But you touch on something there that I think is good to wrap this podcast on, and it's inflation. we're unleashing an incredible amount of pent up demand, which, as you have noted, has an incredible amount of tailwind behind it in terms of buying power for households. That's going to put upward pressure on prices. And in those same surveys that you've noted we are seeing households express concerns about rising inflation.

Ellen Zentner: Now, normally, cyclically, we would be more wary if households were concerned about prices, and prices indeed are rising, if there was a lack of buying power there, but that excess savings that you talk about is going to help cushion them against those rising prices. But, of course, that further feeds on itself. And I think it's something that makes us even more confident in our above consensus calls on inflation.

Ellen Zentner: So, Sarah, thanks for joining me on the podcast today. You know, your views on the consumer are very important to driving the outlook for our team, given that it is 70% of the economy, so it's great to get your views.

Sarah Wolfe: It was great talking to you, Ellen. Thank you for having me on.

Ellen Zentner: And thanks for listening. If you enjoy the show, please leave us a review on Apple Podcasts and share Thoughts on the Market with a friend or colleague today. 

Consumer spending trends are finally accelerating in service sectors such as dining and travel. A look at what this means for GDP, the jobs market and inflation.

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