Despite high inflation and recession fears, the holiday shopping season seems to be off to a good start.
Black Friday and Cyber Monday sales were strong as Americans were lured by deep discounts. Although consumer spending is slowing, it remains surprisingly resilient.
The problem, however, is that many Americans’ paychecks are not keeping up with stubborn inflation. This has forced consumers to finance their shopping sprees by dipping into their savings and using increasingly expensive credit cards.
Not only is this unsustainable, but it could force consumers to cut spending in the coming months to pay down debt and replenish their savings. And that would be problematic for an economy that is driven by consumer spending.
“There will be an inevitable hangover during the holidays. And it will be particularly bad this time,” said Joe Brusuelas, chief economist at consultancy RSM. “It will be the first time that the American middle class has really buckled under the pressure of high prices.”
Inflation-weary consumers saved less money, a trend that preceded this holiday season.
The personal savings rate – how much people save as a percentage of personal disposable income – spiked at the start of Covid-19 as many Americans received stimulus checks and stopped commuting.
But the savings rate has since fallen, largely due to the high cost of living. The savings rate fell to just 2.3% in October, according to government statistics released last week.
Goldman Sachs economists described this as an “exceptionally low” savings rate, noting in a report to clients this week that it is just slightly above the record high of 2.15% set during the housing boom. from 2005.
In contrast, the savings rate in 2019 averaged nearly 9%, according to Moody’s.
“The lack of reality [inflation-adjusted] incomes are starting to catch up with the middle class and the working poor,” Brusuelas said.
The good news is that consumers, as a whole, have racked up an epic accumulation of savings during the pandemic.
The Federal Reserve estimates that so-called excess savings peaked at $2.3 trillion in the third quarter of 2021.
The bad news is that the mountain of cash is dwindling as consumers struggle to keep up with inflation.
“Financial cushions are shrinking rapidly,” Moody’s economists wrote in a note to clients.
The savings surplus fell to around $1.7 trillion by the middle of this year, according to Fed estimates. At the end of September, it fell further to around $1.5 trillion, according to RSM estimates.
“That trillion and a half dollars will run out in the middle of next year,” Jamie Dimon, CEO of JPMorgan Chase, told CNBC earlier this week, noting that inflation is “eroding” the savings pile.
Dimon said this reduction in savings is one of the things that “could very well derail the economy and cause a mild or severe recession that people are worried about.”
A recent Vanguard survey showed a “worrying” increase in hardship withdrawals, or the money workers take out of their employer’s retirement programs, like 401(k) plans.
“The recent increase in the number of households dipping into their employer-sponsored retirement accounts…may be a sign of some deterioration in the financial health of the American consumer,” said Fiona Greig, global head of research. and investor policy at Vanguard.
Of course, the savings pile is not evenly distributed. It leans towards the wealthiest households.
Moody’s data shows that the highest-earning quartile of Americans still has a mountain of savings totaling about $800 billion. In contrast, the bottom quartile has already saved a good chunk of its savings and has about $100 billion left.
Credit card companies are beginning to see a divide between consumers with high and low credit scores.
“Preferred households have enough cash to handle inflation,” Roger Crosby Hochschild, CEO of Discover Financial Services, told a Goldman Sachs conference this week. “You see stress in subprime and near-prime issuers where these households are already depleted. They already buy from Dollar General or low-end retailers.
Brian Wenzel, chief financial officer of credit card issuer Synchrony Financial, said the cost of living was clearly having an impact on some borrowers.
“What we’re hearing today is, ‘Hey listen, I can’t pay my rent, it’s up. Inflation is killing me on gas and groceries. You see that,” Wenzel said at the conference.
Even some high-income Americans are in a rush.
Bank of America, citing internal customer data, said high-income consumers are bargaining at the supermarket and spending far more on cheap groceries than they did pre-Covid.
The timing for Americans to rely on credit cards and savings is not ideal.
“Unfortunately, they’re dipping into their savings ahead of what looks like a slowdown at best and a recession at worst next year,” RSM’s Brusuelas said.
Credit card rates have hit record highs as the Federal Reserve scrambles to fight inflation with massive rate hikes. Some private label credit card rates have exceeded 30%.
There are reasons to hope that consumer finances could improve if inflation slows.
Aneta Markowska, chief economist at Jefferies, expects the gap between inflation and wages to narrow or even reverse in the coming months, giving Americans a chance to catch up. She pointed out that real wages, adjusted for inflation, have turned positive in recent months. Markowska expects this trend to continue, especially as companies make annual increases that will take effect early next year.
“The short-term outlook is correct. Consumer finances are still healthy, but not as healthy as 12 months ago,” Markowska said.
And so far, the job market has largely held up. Hiring is slowing but remains strong and initial claims for unemployment insurance are relatively weak.
Markowska expects consumer spending to remain strong until layoffs pick up steam, likely in the third quarter of next year. That’s when she expects the economy to start shedding jobs on a monthly basis.
“The consumer will likely crack when the labor market cracks,” she said.
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