Running on Fumes?

All things considered, the US consumer continues to hold up okay.  The National Retail Federation (NRF) reported today that “a record 196.7 million Americans shopped in stores and online during the five-day holiday shopping period from Thanksgiving Day through Cyber Monday.”  That figure was up by nearly 17 million compared to 2021 and represents 76% of total US consumers (compared to just 70% last year).  Consumers spent an average of $325.44 on holiday-related purchases over the long weekend, up 8% from last year.  For the entire holiday season (defined as November 1^st through December 31^st), the NRF expects that retail sales will grow 6%-8% over 2021 to between $942.6 billion and $960.4 billion.  Not too bad for an economy that many believe is in recession.  But keep in mind that inflation is currently running in that 6%-8% rate.    

But are we getting close to the end of the road with regard to our free-spending ways?  US consumers, whose spending typically represents 67%-68% of GDP, have three sources for spending money: income, savings and borrowing.  In the chart below, we show the growth trends in these three funding sources, along with the trend in inflation as represented by the year-over-year growth in the Consumer Price Index (CPI). 

First let’s look at the trend in household incomes.  In the chart, we show the year-over-year growth rate in Disposable Personal Income (DPI), which is represented by the yellow line (right axis).  You can see that income growth was very strong in the initial few quarters following COVID’s arrival, and this growth was mostly due to government stimulus initiatives that provided short-term support designed to get folks through COVID.  Since the lion’s share of those stimulus programs have now expired, income growth has come way down.  In fact, DPI actually dropped 1%-2% through the first three quarters of 2022 compared to the same period in 2021.  It stands to reason, then, that consumers, in the aggregate, aren’t spending more as a result of any significant increases in their incomes.   

Next let’s examine the savings rate, which is depicted by the gray line (right axis).  You will see that the savings rate has come way down from a high of over 26% in the first quarter of 2020 to just 2.8% for the most recent quarter (3Q22).  The initial surge in the savings rate reflected the aforementioned stimulus payments as well as the COVID-related lockdowns, which dramatically reduced consumers’ ability to spend on services such as traveling and entertainment.  The dramatic drop in the savings rate last quarter to 2.8%, which is the lowest quarterly rate since 2005, can be attributed, at least in part, to the fact that inflation has far outpaced income growth over the past year and a half.  Many consumers are not only using their entire paychecks but they are also dipping into savings just to meet daily living expenses.  The Fed’s sense of urgency in reducing inflation is a direct response to this hardship, and many economists believe the Fed will remain committed to its current course until growth in the cost of basic necessities subsides.  Bottom line for our purposes?  Savings are now depleted for many consumers and therefore rainy-day funds won’t provide as much support to consumer spending going forward.

Next let’s look at growth in household debt, which is represented by the blue bars (left axis).  Growth in household debt has accelerated dramatically, from a rate of just 2.3% in the first quarter of 2021 to a rate of 8.3% for the most recent quarter (3Q22).  This may not be a surprise to you.  You may have heard on the news that folks are relying on their credit cards more and more to meet expenses.  In fact, credit card debt, which is one subset of total household debt, was up at a 16.3% rate in the third quarter of 2022 compared to the third quarter of 2021.  Auto loans were up 8.0% YOY.  Clearly the consumer is relying more and more on borrowing to make ends meet.  But why? 

Finally, the punchline.  The most interesting part of this analysis, to me, is how closely growth in household debt (blue bars) has tracked the rate of inflation (orange bars).  Just as inflation surged starting in the first quarter of 2021, so did growth in household debt.  The inescapable conclusion, in my opinion, is that consumers are beginning to feel the pinch of inflation.  Their incomes aren’t growing fast enough to keep up with rising prices.  At the same time, many have now burned through the government stimulus checks that carried them through the past couple of years.  So what do they turn to?  Debt.  Total household debt increased by $1.9 trillion, or 13%, from the first quarter of 2021 to the third quarter of 2022, which is when inflation started to surge.  Coincidence?  Unlikely.    

The incoming data continue to support an economic downturn within the next few quarters.  An economy so dependent on consumer spending can’t withstand such a dramatic pullback in consumer spending power.  Moreover, unemployment hasn’t even started to increase yet.  Yes, there have been many layoff announcements in the news, especially in the technology sector.  But the actual number of unemployed people is barely above the level immediately preceding COVID’s arrival.  Future job losses will further reduce the consumer’s ability to spend and defend against a recession. 

The silver lining?  Higher unemployment and lower consumer spending power should dramatically reduce inflation, and lower inflation should reduce the Fed’s urgency to keep raising interest rates.  This is a process, and we are likely still in the early innings.  There will be ups and downs, some of them dramatic.  Hang in there and keep your eyes on the long-term prize.