US consumers are facing a crucial moment as their excess cash, accumulated during the pandemic, is running out. The way they respond to this situation will largely determine whether the world's largest economy can avoid a recession. Over the past couple of years, consumers have dipped into the more than $2 trillion in extra savings they saved during the pandemic in order to maintain their spending levels despite soaring inflation. This has allowed the economy to continue growing, even as the Federal Reserve aggressively raised interest rates.
However, as the cash cushion shrinks, consumers are becoming increasingly reliant on their paychecks to sustain their standard of living. This puts households in a difficult position as they consider how to adjust their spending and whether to take on more debt. Lower-income workers are particularly vulnerable as they have less flexibility to make changes.
Economists are divided on how concerned we should be about this situation. Some economists believe that the strain on consumers, coupled with other upcoming challenges like the resumption of student loan payments in October, could lead to a recession. With credit becoming expensive and harder to obtain due to the actions of the Federal Reserve, consumers may be forced to cut back on their spending, ultimately causing the economy to contract.
On the other hand, there are more optimistic economists who believe that falling inflation rates and a resilient job market will continue to provide consumers with the means to sustain their spending, even as their savings diminish.
Recent data reflects this mixed outlook. US retail sales increased solidly last month, and major retailers such as Walmart, Target, and Home Depot reported profits that exceeded expectations. However, corporate executives have expressed caution about the future, highlighting concerns about weakening consumer balance sheets over time.
During the pandemic, Americans significantly boosted their savings due to government stimulus checks, reduced spending on activities like dining out and vacations, among others. It remains unclear how much of those savings are still intact.
While Fed Chair Jerome Powell has indicated that some residual savings likely remain, he emphasized that the strength of the labor market and workers' income are the primary drivers of consumption and the overall economy. Nonetheless, researchers from the Federal Reserve Bank of San Francisco believe that the extra savings accumulated during the pandemic will likely be depleted by this quarter.
However, Citigroup economist Robert Sockin disagrees with this pessimistic view. He argues that researchers at the Federal Reserve are overestimating the amount of money that Americans desire to save regularly. According to Sockin, households still have around $1.4 trillion in extra cash that they can tap into. This has allowed consumers to continue spending despite tighter credit conditions imposed by the Federal Reserve, delaying the projected recession until the first quarter of next year.
Unfortunately, lower-income households are already feeling the strain of diminishing savings. Bloomberg Economics noted that excess savings for the poorer half of the population have been nearly exhausted, and rising debt-service costs are creating financial stress for these households. Revolving credit, which includes credit card debt, has increased by over 10% in the past year, even with higher borrowing costs. Delinquencies on auto loans and credit cards have also risen.
While these signs of financial distress are not alarming yet, experts at the Brookings Institution express concern that if financially strained households continue to accumulate more debt, it could pose a more significant problem. However, they also highlight that with overall positive job growth and a strong economy, it remains uncertain whether a recession will occur.