Household Savings to Remain Low

Summary

• ‘Excess savings’ have been fully spent, and a low savings rate is driving consumption resiliency.
• This low savings rate reflects full employment, rising wealth, and a recovery in consumer debt – these are unlikely to change anytime soon.

Market Implications

• Growth is likely to keep surprising on the upside, which will lead the Federal Reserve (Fed) to reduce the number of 2024 cuts in this month’s SEP and hike in November 2023.
• This compares with market pricing about a 50% chance of a hike by the November meeting.

Pandemic Transfers Have Been Fully Spent

Consumption has repeatedly surprised on the strong side, which many, including the Fed, attribute to excess savings (i.e., leftover from pandemic transfers). As excess savings are spent, consumption is expected to slow. In this note, I show that excess savings have already been spent and that consumption strength reflects a long-term decline in the household savings rate. 

Excess savings are the difference between actual and pre-pandemic trend savings. They reflect the large government handouts of 2020 and 2021. But these have already been spent (Chart 1). This makes sense as it is now over two years since the second round of handouts in April 2021.

Households Expect Further Real Income Growth

Real consumption growth has resumed roughly on the same trend as pre-pandemic, about 2% YoY (Chart 2). This suggests households expect long-term real income growth to continue its pre-pandemic trend. 

The recovery of consumption to its pre-pandemic trend is exceptionally strong: after the GFC, consumption never returned to its previous path. This time, a decline in the savings rate has enabled the recovery in consumption. This decline likely reflects deviations of real income from its expected trend (i.e., the slow recovery in household real income) and is supported by low unemployment, high wealth, and household re-leveraging (Chart 3). 

Full Employment Has Lowered Precautionary Savings

The return to full employment has been much faster this time (about 2 years) than after the GFC (about 7.5 years). As a result, this time households’ need for precautionary savings is lower. High unemployment tends to be associated with higher savings rates (Chart 4).

Increased Wealth Could Have Lowered Savings

This time, households exited the recession wealthier than they entered it. At end-Q1 2023, household net worth was 7.6 times disposable income, up from 7 times at end-2029. This largely reflects the unprecedented scale of monetary easing and its impact on asset prices.

By contrast, by the end of the 2007-09 recession, household net worth had fallen to 5.3 times disposable income, down from a peak of 6.4 times before the GFC.

Before the GFC, rising household wealth was associated with falling savings rate. This relationship broke down post-GFC, as households deleveraged despite a recovery in wealth. This time, since households are not compelled to deleverage, increased wealth may again be driving low savings.

Households Are Re-Leveraging

The last and most important cause for the currently low household savings rate, is that this time, households are re-leveraging, unlike the post-GFC deleveraging. Total household debt is up 2ppt of disposable income since end-2019 (Chart 6). There are also sharp differences across debt categories:

• Due to the moratoria imposed since 2020, student debt is down 1ppt of disposable income.
• While mortgage debt is up 4ppt of disposable income relative to end-2019, it was flat in Q12023 and fell relative to disposable income. This could reflect that households are locked into their existing mortgages, which carry much lower rates than new ones.
• Credit card balances have recovered sharply from an initial decline in 2020.

Households could be taking advantage of the greater borrowing capacity created by the student debt moratorium and by an effectively blocked mortgage market to borrow to fund consumption. The overall decline in leverage relative to pre-pandemic suggests this could persist.

I do not expect the resumption of student loan repayments to change this, as only one in six American adults has a student loan, which on aggregate represents about 1% of total household net worth. Also, the Biden administration’s new income-driven repayment plan is expected to cut debt service by half and is less at risk from the Supreme Court than the outright forgiveness it had initially planned. Finally, pre-pandemic delinquency rates on student loans are above 10% and could rise further once repayments resume. With 2024 an election year, the administration is unlikely to pursue the delinquents vigorously. 

Market Consequences

This discussion highlights the strength of the recovery and residual impact of the unprecedented pandemic policy easing.

It further suggests that the household savings rate is unlikely to recover soon and that consumption is likely to remain resilient. Therefore, growth is unlikely to slow to 1% in Q4 and to 1.1% in Q4 2024 as the Fed expects. On the contrary, the above analysis supports my conviction that growth will remain above trend and inflation will prove stickier than the Fed expects.

This is likely to impact this month’s FOMC meeting, through a revision of the SEP showing higher growth projections in 2023-24 and fewer cuts than the four currently planned in 2024.

I continue to expect one more hike in November and three more in 2024, starting mid-year.

Dominique Dwor-Frecaut is a macro strategist based in Southern California. She has worked on EM and DMs at hedge funds, on the sell side, the NY Fed , the IMF and the World Bank. She publishes the blog Macro Sis that discusses the drivers of macro returns.

Photo Credit: depositphotos.com

(The commentary contained in the above article does not constitute an offer or a solicitation, or a recommendation to implement or liquidate an investment or to carry out any other transaction. It should not be used as a basis for any investment decision or other decision. Any investment decision should be based on appropriate professional advice specific to your needs.)