Nicolas Micolani
Pandemic savings are gone
The Federal Reserve of San Francisco reported on May 3rd that pandemic savings are gone.
The latest estimates of overall pandemic excess savings remaining in the U.S. economy have turned negative, suggesting that American households fully spent their pandemic-era savings as of March 2024.
This is the chart provided by the San Francisco Fed, which shows that the pandemic excess savings are currently negative at -$72 million. This means that $2.1 trillion in excess savings from the peak in August 2021 are now completely gone. In fact, consumers are dipping into other sources of funds to maintain consumption standards, that's what the negative value of -$72 million means.
San Francisco Fed
The San Francisco Fed researchers define excess savings as " the accumulated difference in actual de-annualized personal savings and the trend implied by data for the 48 months leading up to the first month of the 2020 recession, as defined by the National Bureau of Economic Research".
Fiscal spending growth was the main source of excess savings
The San Francisco Fed researchers also explained (in their 2023 study) that the extraordinary fiscal stimulus was the main source of the excess pandemic savings after the Covid-19 induced recession in 2020. They measure fiscal spending growth as: "Growth in inflation-adjusted non-defense discretionary government spending over the first two years following the onset of a recession as defined by the NBER, relative to the two fiscal years preceding it."
Here is the chart that shows that the fiscal spending measure increased by 35% after the 2020 recession, much more than after the previous recession.
San Francisco Fed
The recession implications
Obviously, the implication is that consumption is now going to slow as the excess savings are depleted, which is likely to lead to a recession. However, a more border analysis is needed to draw more precise implications.
First, it was the combined extraordinary fiscal and monetary stimulus after the Covid-19 pandemic that boosted consumption. In response to the 2020 recession, the Fed also lowered interest rates to 0% and sharply expanded the balance sheet. The consumer was the beneficiary of this combined stimulus in three ways:
- The fiscal transfers or the stimulus checks put money directly in the consumer's pockets. This is the proverbial "helicopter drop of money", or the ultimate stimulus. These funds accumulated in the consumer's bank accounts during the lockdown period after the pandemic, reaching the peak on August 2021. During the process of "reopening" these funds were gradually spent, in what appeared to be a "revenge spending" or a celebration of life on all fun things, such as travel, entertainment...
- The monetary stimulus inflated asset prices, everything from home prices, to the stock market, including alternative assets such as cryptocurrencies. Thus, the asset holders experienced an increase in wealth, which lead to the wealth effect, or spending based on increased confidence and actual wealth.
- However, the wealth effect allowed many workers to prematurely retire, which contributed to the labor shortage, and thus, the increase in wages. A strong labor market and higher wages also provided consumers with additional funds, and confidence, to maintain spending.
So, the excess savings are now gone, and thus the first source of consumption is now gone. However, the job market is still strong, and wage growth is still above the pre-pandemic level, so this could continue to fuel consumption. That's what the researchers from the San Francisco Fed suggest.
However, the April job report shows that the labor market is slowing, with the unemployment rate rising to 3.9% and a slower job creation. Obviously, as excess savings are depleted, at least some consumption of marginal discretionary goods/services will decline, and this will lead to some job losses in those affected sectors. However, this is likely to trigger a vicious cycle, which will lead to a recession in my view.
So, yes, the labor market is still strong, and this could potentially continue to fuel consumption, but we see some early evidence that the labor market is slowing down. It's not a coincidence that Starbucks (SBUX) reported negative revenue growth during the first quarter of 2024, exactly when excess savings turned negative. Also, the leisure and hospitality sector barely created any new jobs in April.
This leads us to the ultimate source of consumption, or the wealth effect. Consumer wealth spiked by 23% after the pandemic, and after a brief dip during the 2022 stock market correction, consumer wealth continues to rise to an all-time high. The stock market and the housing prices are both near the all-time highs.
Here is the chart of consumer wealth.
FRED
The wealth effect makes the consumer more confident, and the confident consumer spends more. But how do consumers tap this wealth to support consumption?
Homeowners can refinance their homes to unlock some of the home value equity. However, interest rates are now high, which makes refinancing inefficient. A massive move to sell homes or stocks would crush the prices, and create negative wealth effect.
Implications for investors
The consumer seems to be "on the ropes".
- The pandemic excess savings are gone.
- The labor market is weakening.
- The wealth locked in the asset holdings is difficult to access without crashing the prices.
The last resort of consumption is credit cards and buy-now-pay later schemes, but I believe this actually plants the seeds of a systematic credit event once the defaults are triggered as the labor market weakens and progresses into job losses.
The stock market is currently still hoping that the Fed will preemptively cut interest rates to prevent a recession and engineer a soft landing. The idea is that the Fed can prevent a recession by inflation asset prices, or increasing the wealth effect, and thus consumption. Obviously, that's not possible as consumers need "real cash" which is only possible by fiscal transfers.
The Fed can only inflate the bubble in my opinion. Thus, the current mode for the S&P500 (SP500) is: the Fed's bubble vs. the forthcoming recession. The market still favors the bubble story.
My strategic outlook for S&P500 is a Sell, but tactically I am considering the probability of an inflating bubble, and thus maintain a Hold rating as long as SPX is above the 50dma, as a risk-management measure.
