The current economic and market cycle is unusual, even unique, in several respects; however, one of the most important is timing.
Historically, bull markets in the S&P 500 don’t peak more than a year before the onset of recession. In this cycle, the S&P 500’s closing peak came on January 3, 2022, more than 16 months ago, yet the US economy clearly isn’t in recession just yet.
Indeed, the US consumer’s resilience so far this year has confounded economists and remains a powerful bulwark against economic downturn:
Source: Bloomberg
This chart shows the quarterly growth in US Gross Domestic Production (GDP) at a seasonally adjusted annualized rate (SAAR) since the fourth quarter of 2021. I’ve also included the contribution from Personal Consumption Expenditures (PCE) for each quarter as a blue bar.
As you can see, consumer spending added to US GDP in every quarter covered by this chart. And, in the first quarter this year, the consumer was the lone bright spot for growth, offsetting weakness in most other components, particularly private investment spending, which sapped 2.34% from US growth.
The consumer has endured despite a catalog of powerful headwinds including a surge in interest rates, the negative wealth effect following a 25%+ decline in the S&P 500 to the lows last October, tightening in lending standards from US banks and inflation at the highest sustained levels in more than 4 decades.
Since consumer spending accounts for around 70% of US GDP, the economy just can’t enter recession unless and until the consumer begins to crack.
As with all economic phenomena, there are multiple drivers of US consumer resilience including the strength in the US labor market – and the lowest unemployment rate since the last 1960s – I’ve written about on multiple occasions in this service.
However, there’s a Federal Reserve paper that’s been making the rounds on trading desks over the past week that strikes at the heart of consumer resilience right now. This paper, titled “The Rise and Fall of Pandemic Excess Savings,” traces the current resilience in consumer spending to the government’s reaction to the last recession in 2020.
You see, the government usually responds to economic and/or market weakness with stimulus both in the form of Fed rate cuts and fiscal stimulus. However, the response to the 2020 COVID outbreak and economy-killing lockdowns was unprecedented – Washington injected more than $5 trillion dollars into the economy through a series of stimulus measures in 2020-21.
You can see that cash in the Bureau of Economic Analysis (BEA) personal income and outlays data here:
Source: Bureau of Economic Analysis (BEA), Bloomberg
This chart shows total personal savings on a seasonally adjusted basis since 2005. As you can see, government fiscal stimulus measures back in May 2008, May 2009 and through 2012 prompted surges in the US savings rate during and following the Great Recession of 2007-09.
In addition, the savings rate tends to rise coming out of an economic downturn as consumers seek to build a cash cushion and repair their personal financial situations following recession.
However, absolutely nothing can compare to what US consumers experienced in 2020 and 2021 as a combination of stimulus checks, direct support for businesses and other measures created two prominent savings “spikes” in April 2020 and March 2021.
In the Fed paper, authors Hamza Abdelrahman and Luiz Oliveira posit a useful means of calculating American consumers’ excess savings built up in 2020-21:
Source: BEA, Bloomberg, San Francisco Federal Reserve “The Rise and Fall of Pandemic Excess Savings”
Simply put, the authors look at the trend in US personal savings over the 4 years up until the start of the 2020 recession and economic lockdowns (through February 2020). They then project that trend in savings through the most recent month (March 2023) and look at actual cumulative consumer savings over the same time. Any cumulative savings above the trend rate are considered excess savings – essentially this is a measure of how much money government stimulus added to US consumer savings in aggregate over the past 3 years compared to a trend rate of savings growth.
As you can see, the peak in excess savings came in August 2011 at $2.11 trillion. Since that time, consumer savings have fallen below the pre-2020 trend rate, meaning this measure of excess savings have fallen back to about $534 billion. In Q1 2023 alone, “excess” savings on this basis fell about $250 billion from just under $800 billion at year-end 2022.
Two Implications of Excess Savings
In prior issues, I’ve suggested the government’s record-setting fiscal and monetary largesse as a potential reason for the long lag time between market peak and recession. However, this paper helps present a quantitative methodology for determining just how large that impact has been and how long it might persist.
Generally, consumers’ willingness to spend more out of savings is lower than their propensity to spend out of current income; however, there’s little doubt this unprecedented surge in consumer savings has acted as a tailwind for consumer spending over the past two years.
I have two additional observations that were not discussed, or not covered at length, in the paper.
First, I’d suggest this excess savings has been a significant driver of the generational surge in inflation we’ve seen since 2021 and its persistence in the face of rising rates over the past year.
Simply put, the price of something rises when demand for that commodity, product or service exceeds the supply. Government-imposed lockdowns and travel restrictions upended global supply chains, which impacted supply of all manner of products and services.
At the same time, government efforts to offset income and savings lost due to the same lockdowns via stimulus – basically the excess savings I just outlined – boosted demand for the same products and services. The effect: restrained supply and rising demand is a perfect storm for upward price pressure.
The same excess savings are now making the Fed’s job more difficult.
There’s not much the Fed can do to address the supply side of the inflation equation. After all, the central bank can’t produce more oil, lower global shipping rates or manufacture more cars to meet demand.
So, the central bank’s main lever is via aggregate demand. By slowing economic growth or sparking a recession through rising rates and tighter credit conditions, the Fed can reduce demand for everything from oil to cars, labor and consumer products which will, over time, bring down prices.
While supply chain issues have begun to recede, excess demand for commodities, goods and services remains an issue.
Normally, rising rates and tighter credit would hit demand, weaken consumer spending, and bring down inflation. However, there’s that pesky $534 billion cash pile of excess savings out there that’s helping to offset and obstruct the Fed’s efforts to reduce demand.
The US government borrowed trillions of dollars to stimulate growth and aggregate demand in 2020-21, and the central bank is now focused on draining that same excess stimulus to bring down inflation and slow the economy.
I believe that’s a major reason why the recession is so “late” this cycle and why the economy appears so resilient even as traditional leading indicators continue to flash red warning signs of trouble ahead.
My second observation is that for almost two years now this cash cushion of excess savings has been shrinking – it’s now down about three-quarters from that summer 2021 peak level. Yet, excess savings are still over a half trillion dollars which, at the Q1 2023 rate of dissipation, would take an additional 2 quarters – through September 2023 – to drop back to the pre-2020 trend level.
Only time will tell if declining savings slows the red-hot US consumer into the second half of 2023, but I believe inflation will remain stubbornly persistent until this lingering stimulus is depleted, keeping the Fed in the proverbial hot seat.
DISCLAIMER: This article is not investment advice and represents the opinions of its author, Elliott Gue. The Free Market Speculator is NOT a securities broker/dealer or an investment advisor. You are responsible for your own investment decisions. All information contained in our newsletters and posts should be independently verified with the companies mentioned, and readers should always conduct their own research and due diligence and consider obtaining professional advice before making any investment decision.