Regular readers of our insights know that we focus on the linkage between the labor market, personal consumption and gross domestic product. Sixty-eight percent of the U.S. economy is driven by spending, and people without jobs, or who are worried about their jobs, do not tend to spend much money. One of the most unusual things about the current economic crisis is that, due to continued social distancing and sheltering at home, even people who want to spend money find it more difficult to do so. This dynamic, on top of historically high job losses, makes for a most difficult spending and economic environment.
These dynamics are starting to show up in the data. After dropping 8.3% from February to March, retail sales plunged an additional 16.4% in April. The rapidity of this decline underscores how quickly households reined in their spending, beginning in March and extending into April. It is not clear whether this trend will linger into the May figures as well or if the gradual reopening of some regional economies will serve to dampen the downside.
Not all retail has suffered. Households still need basic goods but have just shifted how they obtain them. In the nearby graph (now shown on a year-over-year basis), some parts of the retail sector have enjoyed meaningful increases. In particular, non-store retail (think Amazon) rose 21.6% from April 2019. Food and beverage stores are up 12.0%, as households consume more food and drink at home and less at restaurants and bars (down 48.7%). The only other sector to eke out a modest gain is building materials and garden supplies (+0.4%), perhaps as homeowners look for spring projects they can do outside while remaining 6 feet away from other people.
Most economic interaction requires social interaction, and anything that falls into this category has suffered greatly. Auto purchases, a large component of overall spending by value, are down 32.9%, and the 42.8% drop in gasoline sales demonstrates that we aren’t using our cars that much anyway. Home furnishings fell 66.5% year over year, and with the unenviable bottom position on the table, clothing and accessories dropped 89.3%. We believe that this magnitude of decline creates a certain amount of pent-up demand. As and when people venture out again, some of these worst-performing sectors will likely rebound sharply, but almost certainly not to pre-pandemic levels.
Shifts in household debt levels and savings complicate this even further. As with so many other economic and societal trends, this is not a new development. In the wake of the global financial crisis, American households began to strengthen their balance sheets by saving more and spending less, which helps to explain why the economic expansion of the past decade was so modest. A dollar saved, or used to pay down debt, is a dollar that doesn’t contribute to economic growth. This second economic shock in a little over a decade is likely to accelerate this trend toward deleveraging and restoring the financial health of households.
Although we are still in the early days of the current economic dislocation, we may already be seeing this acceleration of savings. While the data can be volatile from month to month, in March households saved 13.1% of their disposable income, a level of savings last seen almost 40 years ago. To be fair, the savings rate is calculated as that portion of income which remains unspent, so the jump shown on the nearby graph may reflect the involuntary savings resulting from the simple inability to jump in a car and pop down to the mall. It will not surprise us if the savings rate reverts to trend growth over the next few months and quarters, but this is precisely our point. The trend has been rising over the past decade and will likely continue to do so once the COVID-19 crisis comes to a much-desired end.
The good news is that, unlike 2008, American households entered into this crisis in relatively good shape, which bodes well for an eventual recovery in consumption. Total consumer debt peaked at $12.7 trillion in third quarter 2008 and didn’t return to that level until first quarter 2017, at which point household income was much higher. Mortgage debt and home equity loans have grown slowly, but even today, housing-related debt is no higher than it was in 2008. Other categories of loans have grown more rapidly (auto and student loans in particular), but household debt remains predominately attached to the asset that is, literally, the household.
The ultimate financial stress on households is not necessarily the size of the debt, but the ability to service it. Delinquencies, therefore, provide an early warning of future impairment to household wealth and spending. To the degree that personal savings, the CARES Act and other unemployment programs succeed in bridging the gap of COVID-19-related economic hiatus, household credit trends should remain sustainable. The most recent data for first quarter 2020 indicates that delinquency trends, particularly in the all-important housing sector, remain fine. Second quarter data will provide a clearer picture.
Serious delinquencies in the housing sector remained modest in the first quarter, around 1%. It seems certain that this will rise in the current quarter, as a rapid deterioration in the labor market will make it harder for some households to pay their mortgages. Student loan delinquencies have remained stubbornly high for almost a decade now. Here, too, continued weakness in the labor market will likely push this rate higher. Credit card and auto loan delinquencies have been on the rise for a few years already and warrant close attention, as they are leading indicators of future credit stress. A financially burdened household is more likely to miss a credit card or auto payment than a mortgage payment.
Even as we make progress in bending the curve of new COVID-19 infections and work to restart business activity, the economic cost of shutting down will reverberate for months or even years throughout the household sector of the economy. Our thesis is that the current economic impairment is temporary and that a quick recovery in employment as states and regions reopen for business will lead to a quick rebound in consumer confidence and spending as well. To be clear, we do not expect an easy return to pre-crisis levels of employment, income, spending and economic growth. The massive and unprecedented dislocation of shutting down the economy will have a lasting toll. We will watch the trends outlined in this brief commentary – and delinquencies in particular – to assess how expensive that toll will be.
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