As Savings Continue to Dwindle, Consumer Spending Is not Sustainable in the Long Term

The $1.7 trillion question for the U.S. economy is how long consumers' savings built up during the pandemic will last.

The answer is that it will likely take another nine to twelve months for the situation to improve.

Consumers saved more money during the Covid-19 pandemic than ever before, thanks to government stimulus and fewer opportunities to spend. This extra cash helped households pay down debt, buy goods like new appliances and furniture during lockdowns and take vacations once restrictions lifted. It gave businesses the flexibility to raise prices and hire more workers to meet stronger demand.

Economists estimate that, as of the third quarter of this year, households still had excess savings of between $1.2 trillion and $1.8 trillion - that is, the amount they saved above and beyond what they would have saved in the absence of the pandemic.

The strong labor market and rising wages have helped consumers continue spending in recent months, despite inflation and mortgage rates being at multidecade highs. U.S. retail sales posted their strongest gain in eight months in October.

There are signs that the buffer is being worked through, and an end is in sight.

This can be seen in the amount of money consumers are saving and borrowing each month.

In 2019, before the pandemic hit, households saved 8.8% of their disposable income. That saving rate jumped to 16.8% in 2020, the highest annual saving rate on record, as government stimulus and unemployment benefits left many consumers with extra cash but few opportunities to spend during lockdowns.

The saving rate has moderated in recent months, falling to 11.8% in 2021 and 3.1% in September 2022. This is near its lowest level since the 2008 financial crisis.

It appears that consumers are spending more and saving less of their monthly income than usual, likely because inflation is causing the prices of goods and services to increase.

Consumers have used their savings to pay down credit-card debt. However, there are signs that this is changing. The Federal Reserve Bank of New York said credit-card balances increased 15% year-over-year in the third quarter, the largest increase in over two decades. The rate of delinquency, that is debt more than 30 days past due, rose across income groups.

These changes will slowly but surely reduce households' savings.

Reduced saving rates can be a sign of financial stress, but that is not the case in aggregate now, according to Ian Shepherdson, chief economist of Pantheon Macroeconomics. He said that consumers are running down a pile of cash, which is not indicative of financial stress.

The amount of money that consumers have left to spend varies according to different economists' estimates. Mr. Shepherdson puts the figure at $1.3 trillion and estimates that, at the current rate of spending, this could last for another year or so. JPMorgan Chase & Co. put the figure at $1.2 to $1.8 trillion in the third quarter, and said that it could be entirely spent by the second half of next year.

Goldman Sachs economists estimate that households have drawn down about 25% of their excess savings and will have spent about 60% of it by the end of 2023. They wrote this past week that “the growth boost from strong balance sheets is probably mostly behind us but … elevated wealth levels will provide a backstop to spending for households that are hit with a negative economic shock.”

This holiday season is expected to be marked by a divide between high-income households that are still able to save and low-income households that are feeling the pinch of rising costs for food, gasoline, and shelter.

According to economists at the Federal Reserve, households in the top half of the income distribution will hold the lion’s share of excess savings in mid-2022, at $1.35 trillion. The lower half of the income distribution is expected to hold about $350 billion.

This holiday season is shaping up to be a strong one for luxury brands, experiential travel, and upper-end resorts. However, it is likely to be a more modest season for those in the bottom income quintiles. This is according to Joseph Brusuelas, chief economist at RSM US LLP.

According to recent earnings reports, American consumers are still spending, although retailers are concerned about how long that can last. Walmart Inc., Lowe’s Cos. and Home Depot Inc. all reported higher sales in the most recent quarter.

According to Walmart's finance chief John David Rainey, one of the things that has helped the company thus far is that consumers have relatively strong balance sheets, assisted by stimulus payments. However, because consumers are stressed by inflation, Rainey says that this won't last forever. As a result, the company is taking a rather cautious view on the consumer.

With the labor market still strong, economists do not expect consumers to dramatically reduce their spending until they see unemployment rising and become concerned about losing their jobs. Economists surveyed by The Wall Street Journal last month expected employers to start cutting jobs in the second and third quarters of next year.