Income rose more than spending due to pandemic stimulus.
The past gap between consumer income and spending—savings—presents the most important factor for expenditures in 2023-2024, though interest rates and the prospect of recession will both play a role in spending decisions. Consumer expenditures will decline because of the Federal Reserve’s interest rate hikes, but the effect on households will be delayed because of their unusually high level of savings.
So far aggregate consumer spending has held up fairly well, but with small declines the two latest months. Household budgets have strained under high inflation. This does not mark the beginning of recession for consumer spending, just some concern and nervousness.
When the Fed is tightening, we expect the early effects on consumer spending to be limited to interest rate sensitive categories: cars, recreational vehicles and boats. The car market is different this time around, as detailed in a previous article. In a nutshell, supply chain problems limited auto and light truck production in recent years. Limited supply pushed prices upward, preventing some prospective purchasers from buying cars. The supply chain problems have diminished, so supply is better. Car manufacturers and dealers have room to drop prices significantly to keep moving cars off of lots. And there remain plenty of people who would buy a new car—at the right price. The volume of spending will be good, but profit margins will drop. That is probably also true of RVs and boats, but the data are not as good for these smaller categories.
Other parts of consumer spending will do fine until ripple effects—resulting from lost jobs and lost salaries—take hold.
Despite news headlines of layoffs, total employment continues to rise. Initial claims for unemployment insurance remain low. The jobs picture will eventually worsen, but so far we have not seen that happen. One key reason is that many companies still have vacant positions. The latest figures show nearly twice as many open positions as unemployed people. This fact does not protect everyone who is laid off; the skills needed for the open positions won’t always match the skills of the unemployed people. In many cases, however, people who have lost jobs have been able to start work at another company with little delay.
Savings above pre-pandemic trend.
The layoffs will eventually take their toll, however, and total wages and salaries paid will decline. The impact this time around, however, will be delayed because of past savings. The stimulus checks that went out in 2020 and 2021 were mostly saved. Savings was higher than normal also because unemployment insurance payouts were more generous, and also wage rates began to rise. The difference between actual savings and what would have been likely in the absence of the pandemic and stimulus we call “excess savings.” It hit a peak, by my calculations, of $2.3 trillion in the summer of 2021. Then consumers started spending more than usual, gradually working down their excess savings. The amount was $1.2 trillion at year-end, or about a 12-month supply at recent spending rates.
The large economic forces make for a positive consumer spending outlook for 2023, though one looking less rosy as the year moves on. By 2024, however, consumers will have less money to spend from current earnings and no excess savings left over, so expect a harsh downturn in discretionary expenditures.
Lesser factors will tend to support spending to a small extent.
Consumer sentiment, as measured by the University of Michigan’s Survey Research Center, is pretty low by historical standards, though not as bad as in mid-2022. The other major survey, The Conference Board’s Consumer Confidence Survey, is middling. Most of the time consumer attitudes reflect fundamentals. In particular, inflation, unemployment and interest rates tend to drive spirits. Right now, inflation is high, unemployment is low, and interest rates are down from their peaks but well above recent years’ levels. So long as war does not break out, consumer attitudes will deteriorate over the course of the year as unemployment rises. Although inflation will eventually drop, boosting spirits, that decline will lag the rise in unemployment.
Household net worth data for the fourth quarter will probably show a gain when the statisticians are finished, with the stock market rebound outweighing a small drop in home values. Wealth is not a big driver of spending, though it can nudge expenditures up or down a little.
Also brightening the spending outlook is the composition of earnings. Lower-wage employees have won the largest pay raises. They tend to spend almost all that they earn, so an extra dollar in those pockets usually means an extra dollar spent. That trend will likely continue in 2023.
Companies selling into the consumer market should not hunker down too soon. Inventories will continue to be necessary to capture the sales that are available. But businesses must be ready for an inevitable downturn in discretionary spending.
