How does consumer spending impact the health of the economy?

Economists and investors continue to scrutinize consumer spending data for signals about the strength of the U.S. economy. Early signs in 2024 are that consumers may be modestly pulling back on spending, but not to the point of hobbling economic growth. Solid consumer spending was key to surprisingly strong economic growth in 2023.

Concerns emerged in early 2024 based on a primary measure of consumer activity, namely retail spending. While retail sales grew by 0.6% in February (compared to January), the previous month’s data was revised downward, showing a spending decline of 1.1%.¹ Even February’s gain in retail activity could be attributed, in part, to the higher prices paid for gasoline. However, in recent months, other data related to consumer activity has been more encouraging.

For example, consumer sentiment is holding at higher levels today than was the case for much of 2023. The University of Michigan’s Consumer Sentiment Index stands 30% higher in March 2024 than at its 2023 low point.² While improved, consumer confidence in recent months have stabilized.

In 2023’s fourth quarter, personal consumption expenditures represented nearly 68% of the nation’s GDP.³ Much of that spending requires financing, some for bigger ticket items like homes, automobiles and higher education and some in the form of credit card debt for day-to-day purchases.

Consumers’ prominent role influencing the direction of the economy is one reason why investors pay close attention to the state of consumer debt. In the fourth quarter of 2023, total household debt in the U.S. reached a record high $17.5 trillion. This represents a 3.6% increase over the amount of debt held one year prior.⁴ Yet that is a slower pace of year-over-year total household debt growth than in the two previous years. “Debt level growth in recent months appears to be in line with wage growth, so at this point, it doesn’t seem to be raising a red flag,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management.

Household savings rates have fallen off from their COVID-19 pandemic-era peaks in early 2020, when they reached a level of close to one-third of disposable personal income. The combination of government stimulus payments and debt relief for individuals and a temporary closing of many U.S. businesses that limited spending options helped boost savings rates. As of January 2024, the personal saving rate was 3.8%.5 “Something closer to 6% is considered typical,” says Haworth. “With savings mostly depleted, the strong labor market, featuring low unemployment and solid wage growth, is helping consumers maintain higher spending levels despite reduced savings,” says Haworth. “We may not see outsized consumer spending in 2024, but there is no reason to expect a significant drop-off.”

Can consumers remain in a position to fuel ongoing economic growth in the face of persistent inflation and higher interest rates? What are the potential economic and capital market implications?

Putting “record household debt” into perspective

The data show that consumers are borrowing at a more rapid pace. This trend emerged in late 2022, according to Haworth. “We saw a meaningful rise in the amount of consumer borrowing, mostly in the form of unsecured revolving credit, like credit cards.” Total credit card debt in the U.S. topped $1 trillion for the first time ever in the second quarter of 2023 and surpassed that record again in the 3^rd and 4^th quarters. Credit card debt increased 14.1% for the one-year period ending December 21, 2023.⁴

The upward trend in consumer debt that began in 2022 contrasted with the two years leading up to that. “Household debt burdens declined during the pandemic,” says Matt Schoeppner, senior economist at U.S. Bank. “Consumers paid off credit card debt and other high interest loans.” However, Schoeppner notes that the economic environment began to change. “As inflation became a burden and government payments ended, consumers were willing to take on more debt,” says Schoeppner.

Haworth notes, however, that some perspective is helpful. “If people are borrowing more money, the question is whether they are in a position to pay it back,” says Haworth. “Consumers today appear to be protecting their balance sheets. They aren’t on a borrowing spree, but borrowing up to a point where it makes sense for them.” As shown in the chart below, through 2023’s third quarter (for which the most recent data is available), household debt service payments represented, on average, less than 10% of disposable personal income. While higher than the recent low point of 8.3% in early 2021, it is far below recent peak levels in 2007 and 2008, when debt amounted to more than 13% of disposable income.⁶

“Following the global financial crisis (from 2007-2009), it appears consumer attitudes and behaviors toward indebtedness have changed,” says Haworth. “Unlike the previous era, consumers today are not so overextended that they will have a hard time paying off debts.”

Manageable consumer debt levels

Schoeppner agrees that rising consumer debt levels do not set off warning signs. “Non-mortgage debt is back to pre-pandemic levels relative to income, but not yet anything of concern. Mortgage debt is still reasonable by recent standards, even with the spike in mortgage rates.”

The jobs market is likely to dictate consumer spending habits. “For now, the labor market remains robust,” says Haworth. A key number to watch is the report on initial weekly jobless claims. The measure rose to 265,000 in June 2023, but dropped since then, most recently to 209,000 new jobless claims for the week ending March 9, 2024.⁷ “It will become more concerning if initial weekly jobless claims consistently rise above 300,000,” says Haworth.

Does consumers’ willingness to continue spending complicate the Federal Reserve’s effort to lower inflation? “The Fed is trying to find a level of borrowing costs that is sufficiently restrictive to slow things down enough to bring inflation back down to its target level of approximately 2%,” says Schoeppner.

Keeping an eye on debt

What is the risk of consumers spending beyond their means in the coming months? Haworth is watching two key indicators:

1. The volume of revolving credit relative to disposable personal income. This metric remains relatively low based on the most recent data. “If it starts to tick up meaningfully, it could trigger more concerns about the potential for consumers to pull back on spending,” says Haworth. That could contribute to recession fears. However, Haworth believes this risk is receding based on recent data.
2. The state of the job market. “If there are signs of weakening, that could indicate consumers will be forced to rein in spending or carry considerably more debt to maintain current spending levels,” says Haworth. “To date, we’re not seeing recessionary signals like a ramping up of layoffs or a contraction in payroll employment numbers.”

It’s important to consider the current economic outlook as you evaluate your own portfolio of investments. Talk to your wealth planning professional to assess how your portfolio can be best positioned, keeping in mind current market dynamics and your long-term financial goals.