Americans like to spend money. A lot of it. Last year, we and our 333 million fellow citizens consumed $19.2 trillion of goods and services, equal to 68 cents of every dollar of gross domestic product (GDP).

Although the tailwind of pandemic-era stimulus largely came to an end in 2021, excess savings, a strong job market, and buoyant housing prices continue to bolster both the ability and willingness of people to spend money, to the benefit of economic growth. As goes the consumer, so goes the economy, and the consumer is going strong.

The resilience of consumer spending is impressive. Most analysts expected that 2023 would mark the long-awaited economic hangover from the trillions of dollars of fiscal stimulus that took place in the wake of the pandemic-induced recession. We’re still waiting.

Real GDP (economic activity adjusted for inflation) actually rose 2.5% in 2023, an acceleration on 2022’s growth pace of 1.9%. The economy added over 3 million jobs in 2023, followed by 1.2 million more in the first five months of this year. The unemployment rate has been at or below 4% for 30 consecutive months.

Despite the rapid rise in mortgage rates, average housing prices nationwide are up 7.2% year over year, which, although a stiff obstacle to first-time home ownership, is a boon to the strength of household balance sheets.

This is about as good as it gets.

And therein lies the problem. Economic conditions in the United States at present remind us of the old witticism that “the optimist believes that we live in the best of all possible worlds, and the pessimist fears this is true.”

As we cross the midyear mark and head into the second half of 2024, we see several cracks in the façade of consumer spending that imply a looming deceleration in economic growth, including diminished strength in the labor market, a rise in consumer debt, a drop in household savings, and a worrisome increase in debt delinquencies.

The Labor Market

The simple model of supply and demand helps to explain the robust job market over the past few years. The labor market had been tightening for a decade prior to the pandemic, as job openings steadily rose (the blue line in the nearby graph) while the available supply of labor (the red line) dropped.

Coming out of the pandemic, companies were desperate for workers, and a sharp rise in job openings reflected this desperation. In March 2022, the imbalance between the supply of and demand for workers topped 6 million, creating a tight labor market and upward pressure on wages.

On an anecdotal basis, this was a constant refrain from our own clients at Brown Brothers Harriman (BBH) just a few years ago: Regardless of geographic location, size of business, or type of industry, workers were hard to hire, and companies therefore wanted all they could get. Job growth subsequently soared. All of the jobs lost during the pandemic had been restored by June 2022, and since then the economy has added a further 6.1 million jobs.

An imbalance between available supply and job openings still lingers, but the gap is narrowing rapidly: Over the first four months of 2024, job openings declined by 2.3 million, while 570,000 people returned to the labor market. Demand for employees is going down, while supply has started to rise.

At this pace, the labor market will come back into balance in the second half of the year, auguring rising unemployment, slower wage growth, and diminished job security. It would be a mistake to interpret this as cataclysmic for the labor market. It is, rather, a return to a more normal relationship between supply and demand, and therefore, a more modest underpinning for consumer confidence and spending.

Consumer Debt

If Americans like to spend, they also like to borrow. Total household debt stood at $17.7 trillion as of first quarter 2024 – up $3.5 trillion since just before the pandemic and up $6.0 trillion over the past decade.

Mortgage debt has been the fastest-growing category (up 23% since fourth quarter 2019), followed closely by auto loans (up 18%) and then credit cards (up 17%). Home equity lines of credit (HELOCs) is the only category to show a decline. In addition to growing incomes and the receipt of fiscal stimulus associated with the pandemic, households have been fueling their spending with rising debt levels as well.

This may look grim at first glance, but the picture is not quite as dire as the headline figures indicate. Yes, debt levels have risen sharply over the past decade, but household incomes and assets have risen even faster. The result is a deleveraging of household balance sheets despite the rise in absolute debt levels:

• Household debt to disposable income has dropped from 135% in 2007 to 97% today, a 23-year low.
• Debt to assets has dropped from a peak of 23.8% in 2009 to 12.5% today, a 49-year low.

Furthermore, because most mortgage debt in the United States is fixed, the rise in interest rates has been slow to hit households. According to the St. Louis Fed, 92% of outstanding residential mortgage debt is fixed. To the degree this debt was assumed or refinanced before the Fed started raising interest rates in 2022, homeowners aren’t paying the prevailing rate of mortgage interest. Although the nationwide average rate for a 30-year fixed mortgage was 7.25% in late June 2024, the effective average rate actually paid by U.S. households was a far lower 3.78%.

As with the labor market, the news on consumer debt is one of marginal change, not radical dislocation. The economic risk here isn’t that consumers suddenly become fiscally prudent and pay down debt levels – the risk is simply that they borrow at a slower rate going forward. This alone would be a brake on the pace of spending and economic activity.

Personal Savings

The flipside of debt is savings: If debt is money spent but not earned, savings is money earned but not spent. Pandemic-era fiscal policy wrought havoc with household savings, as stimulus checks and other forms of fiscal support were injected into the economy precisely at a time when consumers found it hard to spend (in traditional ways, at least) because of COVID-19 restrictions. As shown in the nearby chart, annual savings soared as high as $6.5 trillion, bolstering household finances but also sowing seeds for the inflationary excess consumption that followed.

Annual savings are now back down to a more historically normal $1.5 trillion in absolute dollar terms, but because incomes have risen in the intervening period, the savings rate (savings as a percentage of disposable income) has dropped precipitously.

Decades ago, U.S. households saved 10% to 12% of their income (between 1960 and 1980), before dropping steadily to a low of 4.2% throughout the 2000s. Some of this secular decline is explained by the growing prevalence of two-income households, readier access to credit, and expanded unemployment insurance.

Perhaps predictably, savings rose in the wake of the global financial crisis (GFC), as the twin shock of the housing crisis and rising unemployment prompted Americans to save more. But now, as the fiscal policies of the pandemic recede further into the past, the household savings rate has dropped to a near-record low of 3.6%.

While this is not to say that some economic ill is sure to follow, there isn’t much of a margin of safety in household finances if or when economic conditions deteriorate.

Debt Delinquencies

Take one part soaring debt, mix with a helping of lower savings, add a dash of elevated interest rates, and you’ve got a recipe for financial stress. Rising delinquencies offer the proof in the economic pudding – the evidence that this combination is finally affecting household finances.

The good news is that there are (as of yet) no signs of financial stress in the larger components of personal debt. The nearby graph breaks down serious delinquencies – outstanding debt over 90 days in arrears – by the same categories illustrated earlier in the graph of total debt levels.

The critically important category of mortgage debt shows no real signs of stress: Only 0.6% of outstanding mortgage debt is more than three months delinquent, a measure well below pre-pandemic and even pre-GFC levels. HELOCs are in even better shape.

The worrisome news is the sharp rise in credit card delinquencies over the past few quarters, as missed credit card payments are usually the early warning sign of household financial stress. A strapped borrower will skip a few credit card payments before missing a mortgage or car loan payment: The bank will repossess your car or foreclose on your home, whereas it’s hard for a credit card company to come after you for all those Amazon purchases you made. Credit card delinquencies in first quarter 2024 topped 10% for the first time in over a decade, and we will be watching closely to see if this stress seeps into other categories of consumer debt.

Credit cards are the proverbial canary in the coal mine, and we’re starting to worry about the canary.

What Comes Next?

There is little evidence that these incipient trends are weighing on economic activity at present. Real-time measures of economic activity remain robust. Two (nontraditional) economic measures indicate that discretionary spending is still healthy and that the weight of rising debt, diminished savings, and higher interest rates hasn’t yet constrained spending:

• Passenger air travel in 2024 is up 6.5% vs. last year (through June 17).
• OpenTable dining reservations are up 3.5% year over year (through June 25).

We’ll watch these and other real-time measures to assess when and how rapidly these headwinds to personal consumption begin to affect economic activity.

Economists and pundits love to debate whether any economic landing will be soft or hard, without ever really defining those terms. We won’t offer a definitive definition here either, other than to observe that hard and painful landings in the past have typically coincided with the Federal Reserve mistakenly keeping interest rates too high for too long.

Inflation obviously plays an important role in determining monetary policy. The Fed’s twin mandate is to implement policies that foster full employment (another ill-defined term) while maintaining price stability (a third ill-defined term).

Balancing these vague and often conflicting goals has been relatively easy over the past few years, as the Fed has focused on getting inflation down in a context of strong economic growth. Since last raising interest rates in July 2023, the Fed has maintained the position that there hasn’t been enough further improvement in inflation to allow it to lower interest rates, and at the same time not enough economic challenges to require it to do so.

We believe that both of those calculations will change during the second half of 2024. Headline inflation has dropped from a peak of 9.1% in June 2022 to 3.3% in May 2024, while core inflation – a more important measure of endemic inflation – has dropped from a peak of 6.6% to 3.4%.

Neither are quite yet at the Fed’s preferred level, but as shelter and insurance prices continue to revert to more normal levels, we should see further downside in core measures of inflation, enabling the Fed to respond to early signs of economic anxiety by gradually lowering interest rates. Our best estimate is that the Fed begins to cut interest rates later this year (probably after the November election), followed by more cuts in 2025.

Modestly slower economic activity and falling interest rates form a benign backdrop for financial markets, although heightened volatility has historically accompanied pivots in monetary policy.

As active investors, we consider price volatility our friend, as unpleasant as it may be in the moment, as volatility creates the disconnect between price and value that our analysts and portfolio managers seek to exploit.

In the longer run, our asset allocation strategies and portfolio positions are not predicated on any one economic outcome – or the timing of any particular outcome – but are instead focused on the longer-term needs of our clients and the fundamental returns on offer in specific asset classes and securities.

To learn how we can help you navigate the current economic landscape, reach out to your BBH relationship team.