To this point, Americans have weathered the inflation storm. Can their resilience continue?
Feeling the squeeze despite record-breaking recovery
US employment has rebounded spectacularly following the pandemic shock. The economy has on average created half a million jobs per month over the past 18 months. The labor market has tightened and wage growth has been robust.
So nominal earnings are elevated above trend. But when adjusted for inflation, the story isn’t as rosy. Real disposable incomes have fallen for four consecutive quarters as rising prices eat away at consumer purchasing power.
Of course, inflation isn’t the only story here. Stimulus efforts during the pandemic have also rolled off over the past year as unemployment insurance payments normalize and child tax-credit top-ups expire.
Chart 1: Inflation has eaten away at what should have been significant income gains
Source: Bureau of Economic Analysis/Haver Analytics, May 2022
Despite these headwinds, spending continues to rise. Over the past 12 months, spending is up 2.3% in real terms, which isn’t necessarily an enormous gain, but it does represent impressive resilience in the face of a historic squeeze on real incomes.
The personal savings rate has declined to 6.2%, a rapid normalization from pandemic highs of 30%.
While spending is rising, saving is declining. The personal savings rate has declined to 6.2%, a rapid normalization from pandemic highs of 30%. Current savings rates are well below pre-pandemic levels.
Scratching the surface of pandemic savings buffers
We believe that the savings rate has dropped so dramatically through a combination of some households saving less and others drawing down their pandemic savings stockpiles.
By our calculations, US households have drawn down about $85 billion of these excess savings in the past six months, which has driven the rise in spending. But still, this $85 billion drawdown is just a scratch on the surface of Americans’ savings of about $2.4 trillion.
To put this into context, this amount represents a little more than 10% of 2021 US GDP. It’s clear that these pandemic savings buffers have helped households weather the inflation storm to this point.
Big spenders hold most of the cash
The richest Americans have seen the largest savings increases. The top 10% of Americans with the highest net worth have seen almost $2 trillion added to their checking accounts over the course of the pandemic. The bottom 50% gained less than $200 billion.
However, there are reasons why this disparity should not cause undue concern over consumer spending:
- The top 10% highest-income US households are far and away the biggest spenders. They collectively spend as much as the bottom 40%.
- Even though the $200 billion that the bottom 50% has saved is much less than the $2 trillion of the top 10%, it’s still a lot. Checking-account balances are up 150% from pre-pandemic levels among the bottom half of the wealth distribution.
- Lower-income workers have seen strong wage gains over recent months. The Atlanta Fed wage tracker reports a 6% year-over-year increase in wages among the bottom quartile. This likely limits some of the real hit to incomes in these households.
- There are few signs of credit-card delinquencies. While credit-card debt continues to recover from the pandemic, the level of debt as a share of income remains well below the pre-pandemic average.
So, even though higher-income households have accumulated greater savings than their lower-income counterparts, we don’t think that this will significantly undermine consumer spending looking ahead.
Fed pushes back on growth to tame inflation
Following the May 4 US Federal Reserve (Fed) meeting, Chairman Jerome Powell quashed speculation of a 0.75% interest-rate hike. But he also suggested that the next two Fed meetings will introduce 0.50% interest-rate hikes.
This aligns with our forecasts, which include 0.50% interest-rate hikes at the June and July Fed meetings, and the Fed Funds’ rate ending the year just shy of the Fed’s 2.4% view of neutral.
The Fed also announced that it would start reducing its balance sheet by $47.5 billion per month in June — $30 billion in Treasuries and $17.5 billion in mortgage-backed securities (MBS). This rate will continue for several months before increasing to a total of $95 billion in August — $60 billion in Treasuries and $35 billion in MBS. The Fed is hoping this balance-sheet reduction will occur in the background, with interest rates taking center stage as the active and marginal policy tool.
This could make households less willing to spend
Higher interest rates and tighter financial conditions ought to make households less inclined to spend at the margin through standard interest-rate channels. But it’s worth noting that short-term real rates remain extremely low. This limits the appeal of savings in cash-like instruments in light of elevated inflation.
Expectations about the economy’s path will also play a large role in driving spending patterns. Typically, savings rates increase when economic conditions are expected to deteriorate. So, if households expect an increased risk of recession over the next few years, this might blunt the run-down in savings needed to support consumption.
Still, the sheer scale of savings sitting on household balance sheets and their willingness to use them suggests that households might be less interest-rate sensitive than in the past. The fact that household debt as a share of GDP is at multi-year lows, and much of this is locked into fixed 30-year mortgage rates, speaks to this dynamic.
The bottom line is: The Fed’s going to pour cold water on the economy
The savings cushion could be a double-edged sword for the economy. Ultimately, the Fed needs to cool an overheating economy to stabilize inflation.
If economic growth proves resilient to expected monetary tightening thanks to smooth consumption from elevated savings, it suggests that further policy-tightening could be necessary, and that therefore economic slowdown is a feature — not a bug — of Fed policy choices.
IMPORTANT INFORMATION
Projections are offered as opinion and are not reflective of potential performance. Projections are not guaranteed and actual events or results may differ materially.
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