Update 785 – Shifts in Saving, Spending:
Macro Implications of Consumer Behavior
Evidence of the long-and-variable lag effect of the Fed’s year-old elevated interest rates on the economy is mounting. Yesterday’s Job Openings and Labor Turnover Survey (JOLTS) report for April showed the steepest drop in job openings by almost 300,000 — the largest drop in over three years. On the demand side, focus is on the consumer, the engine behind the strong U.S. economic recovery from the pandemic.
At the heart of the nation’s globally envied but domestically underappreciated bounceback has been the consumer, driving demand and growth. There are some signs that consumers, especially low-income consumers, are running out of savings and are increasingly relying on credit cards to finance purchases. Today, we focus on trends in consumer behavior and consider the election year macroeconomic implications.
Best,
Dana
Consumer spending comprises roughly two-thirds of America’s gross domestic product (GDP). As such, fluctuations in consumer spending can have an outsized effect on measures of economic performance. Consumer spending has remained fairly strong in the post-pandemic recovery, even as inflation and high interest rates have made the economy less friendly to consumers, despite inflation having decreased considerably from its recent high.
That said, there are signs that consumers are tightening their belts and buying less, and financing more. Should consumer spending slow, it could augur more difficult economic times as America gets closer to the 2024 election, with the economy the top issue currently in voters’ minds.
The State of Consumer Spending
The most recent GDP report from the Bureau of Economic Analysis showed consumer spending growing by 2 percent in the first quarter of 2024. Though this is not alarmingly low, it is down from stronger growth of 2.8 percent in the previous quarter. Spending on goods fell at an annual rate of 1.9 percent, offset by a 3.9 percent increase in spending on services. Spending on durable goods – goods that last a long time, like vehicles or furniture – fell by 4.1 percent, while spending on non-durable goods – goods that are used quickly, like food and gasoline – fell by 0.6 percent. That said, while consumer spending slowed, there is a silver lining: consumer confidence rose to 102.0 in May, up from 97.5 in April, after three months of decline.
According to a recent survey by consulting firm Mckinsey & Company, consumers expect to increase their savings on essentials, including food items, baby supplies, and other groceries, over the next three months. Expectations for spending on gasoline in particular saw a significant increase since the previous quarter. By contrast, consumers said they expected to see either a decrease or no change in spending on semi-discretionary products, such as personal care products and household supplies, and expected to spend less on discretionary items, particularly travel and hospitality.
Additionally, consumers continued to “trade down,” or reduce the quantities they bought, search for better prices, or delay purchasing entirely. This trend was particularly pronounced among young consumers, with 56 percent of Gen Z and Millennial shoppers trading down compared to 45 percent of older consumers.
Finally, consumers’ plans to “splurge” plateaued across all income and age cohorts, though dining out, groceries, and apparel continued to be the most popular splurge categories. All of this suggests that consumers are focusing on buying the necessities while reducing their discretionary spending.
By all appearances, consumer spending is feeling the combined pain of high inflation and high interest rates. To this point, consumer spending has stayed strong due to a strong labor market, low unemployment, and solid wage growth, with, real wages growing 0.5 percent in April, representing 12 straight months of wage growth outpacing inflation, buoying consumer spending as Americans continue to deal with inflated prices. While consumer spending may continue to grow in the coming months, the evidence suggests instead that slower growth is on the horizon.
The State of Consumer Debt
A key component of the overall picture of consumer spending is consumer debt. Pandemic-era savings, the difference between actual savings and the pre-pandemic trend, swelled to $2.1 trillion between March 2020 and August 2021. These savings helped American families weather economic hardship while also propping up consumer spending and the economy at large. By now, these savings have dried up. Growth in Americans’ real disposable incomes, or their real incomes after taxes are deducted, has slowed to a crawl.
Source: Bloomberg
As a result, American consumers have increasingly turned to consumer debt to prop up their spending and maintain their current standards of living. Total household debt grew by $184 billion to reach a record high of $17.69 trillion in the first quarter of 2024. The largest debt category was mortgages, which increased $190 billion to $12.44 trillion. Auto loans and student loans were the next largest categories, standing at $1.62 trillion and $1.595 trillion respectively. Notably, credit card debt shrank by $14 billion to $1.12 trillion, but that is fairly typical of the first quarter. According to an analysis by US Bank, household debt increased across the board between Q4 2022 and Q4 2023:
- 14.1 percent increase in credit card debt
- 3.9 percent increase in auto loan debt
- 2.9 percent increase in home mortgage debt
- 0.3 percent increase in student loan debt
- 7.8 percent increase in all other debt
Total household debt increased by 3.6 percent in 2023, a fairly modest increase compared to 2021 and 2022:
Source: US Bank
In light of this increase in consumer debt, a major concern is whether Americans can pay it off. Per the New York Fed, 1.54 percent of all debt is currently seriously delinquent (90 days or more overdue). Credit card debt is of greatest concern: in addition to the fact that it’s the fastest-growing category of debt, it has also seen the greatest increase in delinquencies, with 6.86 percent of credit card accounts seriously delinquent as compared to 4.57 percent in the same quarter last year. About 1 in 5 American credit card users are maxed out, utilizing at least 90 percent of their credit limit. According to a survey of 2,000 consumers with active consumer debt accounts, the leading reasons for making delinquent payments are inflation and a reduction in income.
There are some reasons not to panic just yet over the state of consumer debt. In 2023, household debt payments accounted for a little less than 10 percent of Americans’ disposable income, which is higher than the recent low point of 8.3 percent in early 2021 but much lower than the peak of more than 13 percent in 2007 and 2008 — suggesting that consumers’ ability to pay their debts remains strong for now.
Source: US Bank
Additionally, outstanding balances of consumer debt that were 30 to 59 days past due fell to 0.86 percent in April, down from a recent peak of 1.04 percent in February. Granted, part of the reason for this is that people were using their tax refunds to partially pay off their debts. Even factoring this in, the year-over-year jump in outstanding balances was smaller than it was last year. This trend was fairly consistent across credit card, home, and auto loans and was present for consumers across the income spectrum. In short, it does not appear that household debt is overwhelming just yet, offering hope that it will not drag spending down for the foreseeable future.
Consumer Spending by Age and Income
American consumers are not a monolith, and trends in consumer spending are not the same across Americans of different ages and income levels. Below, we drill down on two key consumer cohorts to see how spending patterns differ according to age and income.
- Age
Young consumers, for example, are more optimistic about the economy: 41 percent of Gen Z and 38 percent of Millennials surveyed were optimistic about the economy, as compared to 29 percent of Gen X and Baby Boomers. Gen Z in particular persistently went shopping more than other age cohorts in 2023, even as they grappled with inflation, student debt, and rising housing costs.
That said, younger generations are also relying more on credit to fuel their spending, resulting in a rise in credit card delinquencies. Gen Z and Millennial card users have higher delinquency rates, with 15.3 percent and 12.1 percent of all users maxed out respectively. In comparison, only 4.8 percent of Baby Boomer card users are maxed out. There are numerous reasons for young consumers’ reliance on spending on credit. For one, young people are experiencing inflation on essentials such as food and shelter at an early stage in their careers, meaning that they have to spend more while getting paid less. A large portion of young people have student loans, putting further strain on their finances.
- Income
The state of the economy is very different for high-income and low-income consumers. High-income consumers are cushioned from economic headwinds and continue to spend more than middle- and low-income consumers. High-income consumers are locked into low interest rates on their mortgages from before the Fed began hiking rates, and have seen their home equity improve as home prices skyrocket. High-income consumers also have more money to spend due to their investment portfolios, benefiting from a strong post-pandemic performance from the stock market.
Conversely, debt is difficult to escape for low-income households, as they need money to spend on necessities even though inflation has jacked up their prices and their incomes have not increased enough to compensate. As a result, credit card debt is on the rise for low-income consumers. About 56 percent of people earning less than $25,000 carried a credit card balance in 2022, a number that has almost certainly grown. 12.3 percent of card users in the first income quartile (the lowest) were maxed out, as compared to 5.5 percent of card users in the fourth quartile. Note that low-income consumers do not account for a large share of total spending when compared to middle- and high-income consumers, so their struggles will not weigh heavily on economic growth as long as spending from other income cohorts remains strong.
Implications for the Economy
Consumer spending’s outsized share in economic growth means that its implications for the broader economy cannot be ignored. The economy grew at a sluggish 1.3 percent rate in the first quarter, in part due to the slowdown in consumer spending but also due to weak inventory accumulation and a rise in the trade deficit. Higher inflation is having the biggest impact on consumer spending, while high interest rates increase borrowing costs for consumers, weighing down the economy and hurting wage growth. The future is not looking much better, as many economists expect a slowdown in consumer spending over the year. While strength in other components of the economy, such as government spending and business investment, could help keep the economy afloat, they would not be able to prop up economic growth should spending drop considerably below 2 percent.
A pronounced drop in consumer spending could lead to a recession. Consumer spending fell 7 percent during the COVID-19 recession and 3 percent during the Great Recession. Still, as demonstrated by a study from the Dallas Fed, continued consumer spending is no guarantee that the economy will hold either, as consumption tends to grow in the two quarters leading up to a recession.
With major action from Washington unlikely this close to the election, the only institution likely to make a big impact on consumer spending is the Fed. To this end, the Fed is in something of a bind. The best way for the Fed to fight inflation is to keep interest rates higher for longer, but doing so reduces borrowing and drags down the economy; in short, both cutting interest rates and maintaining them could hurt consumers. The Fed should give more consideration to cutting rates sooner rather than later. That said, the Fed has indicated that it has little interest in cutting rates before it has made more progress in achieving its target rate of 2 percent inflation — barring a major economic downturn. With a fiscal policy intervention in the economy unlikely, one can only hope for a soft landing, with consumer spending continuing to hold until high interest rates can finally start to reverse.