How does consumer spending impact the health of the economy?

The U.S. economic expansion continues despite challenges such as persistent inflation and higher interest rates. Key to Gross Domestic Product (GDP) growth of 1.4% in the first quarter was steady consumer spending.¹

Retail sales have trended modestly higher this year, with the most significant changes attributed to growth among e-commerce retailers.2 As has been the case in recent times, spending on goods remains relatively flat, but services spending grew solidly.²

“Consumers may be feeling somewhat of a wealth effect from recent strong stock market returns,” says Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management. “They are saving less while maintaining a solid rate of spending.” Haworth says a strong labor market accompanied by competitive wage gains has helped consumers continue to contribute to the ongoing economic expansion.

Can consumers keep spending sufficiently to boost the economy? Consumer confidence surveys may provide an indication of consumers’ expectations and attitudes, and the most recent data sends mixed signals. The University of Michigan’s Consumer Sentiment Index was 6% higher in June 2024 from a year earlier, but the number was slightly lower in June than it was in May, representing its lowest reading in seven months.³ Similarly another measure of consumer confidence from the Conference Board also declined in June, but has generally tracked at a consistent level over the past two years.⁴

In 2024’s first quarter, personal consumption expenditures represented nearly 68% of the nation’s GDP.¹ 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.

An increasing proportion of spending is the result of rising consumer debt. In the first quarter of 2023, total household debt in the U.S. reached a record high $17.7 trillion. This represents a 3.8% increase over the amount of debt held one year prior but may not yet be a major concern.⁵ “While we’ve seen some a modest rise in delinquency reports, representing people not keeping up with debt payments, it’s not yet at a concerning level,” says Haworth.

Household savings rates have fallen off from their unusual COVID-19 pandemic-era peaks in early 2020, when they reached a level of close to one-third of disposable personal income. As of May 2024, the personal saving rate was 3.9%, trending higher from its recent low level of 3.6% in March.⁶ “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,” says Haworth.

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

Consumers are borrowing at a record pace, but the upward trend of overall borrowing has been gradual. Of all major debt categories, credit card debt is growing the fastest. Total U.S. credit card debt topped $1 trillion for the first time ever in the second quarter of 2023 and continues to move higher, increasing 12.1% for the one-year period ending March 31, 2023.⁵

While borrowing is on the rise, Haworth cautions that some perspective is helpful. “Consumers today 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 (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.⁷

“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

“Non-mortgage debt is back to pre-pandemic levels relative to income, but not yet anything of concern,” says Matt Schoeppner, senior economist at U.S. Bank. “Mortgage debt is still reasonable by recent standards, even with the spike in mortgage rates.”

The jobs market heavily influences 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 has been lower since, most recently at 238,000 new jobless claims for the week ending June 29, 2024.8 “It will become more concerning if initial weekly jobless claims consistently rise above 300,000,” says Haworth. “While the unemployment rate has nudged higher in recent months (to 4.1%), that’s partly due to the labor force participation rate rising, which is a positive economic development.”

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:

• 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.
• The state of the job market. “If there are signs of weakening employment measures, 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, and job openings remain high relative to the number of available unemployed workers.”

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.