How Long Can Consumers Rely on Savings?

 

Summary

Consumers have yet to lose their staying power, and our analysis of household finances suggests consumers still have the ability to rely on their balance sheets for some time yet. The catch: The more consumers rely on their balance sheets to spend today, the larger deterioration we'll see in overall household finances and the worse the eventual economic downturn may be.

We Called It 'Staying Power' for a Reason

There is a lot riding on whether consumers continue to spend. Dialing in on the precise timing of a downturn in some ways comes down to when households decide to pull back on consumption, and recent data indicate consumers have yet to lose their staying power.

Despite decades-high inflation making everything from a tank of gas to a meal out more expensive, households continue to spend, and do so at an elevated pace. That's due to household balance sheets, which remain healthy and are allowing consumers to sustain spending even as high inflation erodes much of the wage gains workers are enjoying. More plainly, real spending is outstripping real income at an unusual rate (Figure 1).

Households are drawing down personal savings stashed away during the early days of the pandemic, saving less of their monthly income and/or putting more on their credit cards to consume. Even as consumers have leaned on their finances, causing some deterioration in overall wealth, we argue households still have the ability to rely on these alternate sources to consume for some time yet. It's thus the willingness rather than ability to consume that becomes most important in understanding the near-term trajectory for consumption.

Source: U.S. Department of Commerce and Wells Fargo Economics

Cashed Out or Stashed Up?

Despite concern over COVID having largely faded to the background for many households, recent resiliency in spending is still in part explained by the massive amount of savings that was accumulated throughout the pandemic.1 In fact, recent data revisions indicate consumers have actually been drawing down excess cash at roughly twice the pace previously reported. Even withstanding the revisions, we estimate households still have roughly $1.3 trillion in accumulated savings through August, which is equivalent to about 8% of annual consumer spending (Figure 2). That translates to over a year's worth of excess capital remaining, as it would take households another 15 months to completely deplete this stockpile if they continued to draw it down at the $85 billion average monthly pace they have over the past six months.

Recall, however, that we do not expect all of this estimated stocked "cash” is sitting idly and ready to be deployed. Due to the simple way personal saving is measured as the inflow of disposable income less the outflow of outlays, the acquisition of assets shows up in saving. Thus, some of this excess savings has likely been used to pay down debt, purchase a home or made its way into brokerage or retirement investments, and is thus not available to use on outlays today.2

Even so, real aggregate checking and saving account balances suggest households have more dry powder ready to deploy over the next few months. Real household deposits peaked in the first quarter and were roughly $2.6 trillion higher than where deposits would have been had they followed the pre-pandemic rate of growth. Since then, the gap between deposits and trend has steadily narrowed, but aggregate household balances remain robust and roughly $1.7 trillion above trend (Figure 3). In fact, if deposits continue to decline at the average rate they have over the past three quarters, the excess savings from 2020 and 2021 will be wiped out by Q3-2023. While real cash assets are starting to deteriorate, households are still to an extent flush with cash.

Source: U.S. Department of Commerce and Wells Fargo Economics

Source: Federal Reserve Board and Wells Fargo Economics

Insert, Tap Today, Pay Tomorrow

Beyond tapping stashed cash, households are also increasingly reaching for their credit cards. Revolving consumer credit, which is mostly composed of credit card debt, has grown in each of the past 17 months, with the level outstanding currently about 5% higher than it was prior to the pandemic (Figure 4). Even with recent momentum exhibited by the three-month annualized change in revolving debt higher than at any point during the past cycle, households are not yet overleveraged.

Outstanding revolving credit still remains nearly 5% below where it would have been in the absence of the pandemic had credit continued to grow at its pre-pandemic trend pace. Furthermore, most liability ratios suggest household monthly and quarterly debt payments remain low. For example, despite revolving credit shooting higher, the amount outstanding still remains near a historically-low level when taken as a share of disposable income. More broadly, household financial obligations and debt-service ratios also remain very manageable on a macro level (Figure 5).

But financing costs are set to only move higher amid tighter Fed policy, which should constrain borrowing. Households are likely already feeling this to a certain extent, with the average annual percentage rate on credit cards reaching 16.3% in August, marking the highest rate in data going back to the mid-1990s. Beyond higher interest on credit cards, however, unless households hold an adjustable-rate mortgage many consumers have relatively low sensitivity in the form of monthly obligations, though rates influence new demand such as purchasing a home or vehicle. Recently announced student loan debt forgiveness also will reduce monthly interest payments for some households, freeing up some cash in monthly budgets.

Source: Federal Reserve Board and Wells Fargo Economics

Source: Federal Reserve Board and Wells Fargo Economics

This Must Be the Rainy Day

With households spending more than they are bringing in, the personal saving rate has plunged and households are saving at rates last sustained in the run-up to the 2008 financial crisis (Figure 6). The deterioration in finances is also evident in the roughly 4% decline in net worth in the second quarter. Historically, there has only been a sharper quarterly reversal in wealth in the fourth quarter of 2008 and first quarter of 2020, corresponding to the recessions in those periods.

Consistent with what we’ve seen in financial markets, the fall in equity values was responsible for most of the decline in net worth, which led to a larger drop in wealthier cohorts who hold more equities as assets. The bottom 50% of households actually saw their net worth increase in the second quarter due to a large rise in the value of real estate, which represents a bulk of their assets at nearly 60% (Figure 7).3

The net worth data are, however, inherently backward-looking. Equity values according to the S&P are off another 5% through the third quarter, and home values have started to reverse, both of which will weigh on net worth and eventually lead consumers to cut back on spending. Key word being eventually. Consumers tend to be more concerned with the directional change in their household wealth than its absolute level when it comes to spending plans. Whatever comfort the consumer may be able to take in it, the absolute level of total household net worth is still about 24% above pre-pandemic levels and signals consumers can sustain spending at an elevated pace. That combined with the ability to continue to take on leverage and draw down cash means consumers likely won’t stop spending just yet. No matter how it's funded, spending will continue to exert modest downward pressure on the personal saving rate, which we expect to hover in the 3% range through the middle of next year.

Source: U.S. Department of Commerce and Wells Fargo Economics

Source: Federal Reserve Board and Wells Fargo Economics

This Isn't Sustainable

While consumer staying power has not yet run out, it's not infinitely sustainable. The more consumers rely on their balance sheets, the larger deterioration we'll see in overall household finances and the worse the eventual economic downturn may be. The recent resilience in spending led us to recently push out the timing of recession in our forecast from the start of next year to the second quarter. With near-term spending coming at a further deterioration in finances, we also now look for a slightly larger decline in real personal consumption expenditures with a peak-to-trough decline of 1.0% compared to 0.6% previously.

A potential near-term and more sustainable source of purchasing power could come if we see a meaningful reprieve in inflation. Easing inflation amid continued wage gains could give way to modest real income growth. The easing in prices needed, however, seems unlikely as high demand is in a way acting in a feedback loop to inflation and preventing price growth from materially falling. Furthermore, as real rates turn positive next year and the lagged effects of tighter policy bite, it is going to be more challenging for consumers to rely on their balance sheets. We suspect this will lead households to pull back more meaningfully on spending, ushering in a mild economic contraction.

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