The writer is an FT contributing editor and global chief economist at Kroll
It may be the most anticipated recession in history. Economists have been forecasting contraction for the US economy since at least April, shortly after the Federal Reserve began raising interest rates. But a bit like Godot, it has yet to show up. Credit the cash cushion American consumers and corporations built during the pandemic. But that will eventually disappear, and then the economy will nosedive.
In 2020 and 2021, generous unemployment insurance benefits, stimulus cheques and child tax credit payments helped households squirrel away roughly $2.3tn in excess savings — the amount above what they would have saved had there been no pandemic. This powered a surge in demand as the economy reopened (fuelling upward pressure on inflation). October retail sales posted their strongest gain in eight months. Consumption accounts for more than two-thirds of US gross domestic product growth, and so far spending has remained strong.
But with consumer price inflation running at 7.7 per cent in October and median wages rising 6 per cent, according to the Atlanta Fed’s wage growth tracker, people’s standards of living are falling. As stimulus programmes ended last year and the economy reopened — increasing opportunities to spend money — Americans’ cash war chest has been dwindling, and the spending extravaganza cannot last. Economists’ estimates for how much is left vary from about $1.2tn to $1.8tn.
Forecasts for how long the cash will last also vary, based on assumptions about the labour market, spending and GDP. Bank of America expects that at the current three-month average rate of decline of household deposits, it would take between 12 and about 40 months (depending on income quartile) to return to 2019 levels. Goldman Sachs estimates US households will have less than $1tn in excess savings by the end of 2023. JPMorgan recently warned excess savings could be completely depleted by the second half of next year.
There are many reasons to fall on the pessimistic side of these estimates. The personal savings rate jumped from 8.3 per cent at the end of 2019 to 26.3 per cent at the height of Covid-19 in March 2021. In September it had fallen back to 3.1 per cent, well below the historical average. And for all the cash still left in aggregate household bank accounts, consumers are not feeling very confident. The Conference Board’s consumer confidence index has been declining since mid-2021.
Consumer indebtedness is rising, another sign some households are running low on savings. According to the New York Fed, total household debt increased $351bn in the third quarter, the largest nominal increase since 2007. Credit card balances ballooned 15 per cent over a year earlier, the biggest rise in two decades. And while the rate of delinquencies — debt more than 30 days past due — on consumer loans and credit cards remains below historical averages, it is on the rise.
Companies, like households, have also seen cash buffers soar over the pandemic thanks to fiscal measures such as the Paycheck Protection Programme and ultra-easy monetary policy. New orders of non-defence capital goods excluding aircraft — a proxy for capital expenditure — have remained on a strong upward trajectory since April 2020, suggesting companies are still happy to spend.
But with borrowing rates continuing to rise and profits likely to dwindle, this can’t last for ever. Corporate cash on hand is still well above pre-Covid levels, but is down sharply since the third quarter of 2021. Surveys suggest companies big and small are pulling back on capital investment over the next few months, another sign they are feeling a squeeze despite their cash position.
It’s a feedback loop to watch. If companies are pulling back, fewer people will be drawing pay cheques. And historically, spending decisions have been based more on job prospects than savings. The US has a very tight labour market, probably influenced by savings-buffered demand. Unemployment has ticked up only marginally from a post-pandemic low of 3.5 per cent. Average hourly earnings growth has decelerated from 5.6 per cent in March 2022 to 4.7 per cent in October, still well above the historical average. But as the Fed raises rates to damp demand, the labour market will deteriorate.
In the months ahead, the cash war chest will dwindle, earnings will suffer and unemployment will rise. Godot never came, but a recession will, sooner or later. Whether a soft or hard landing, there will be a much thinner cash cushion to buffer it.