Thursday, June 30, 2022

Column: As household savings ebb, the sugar high wears off

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By Mike Dolan

LONDON (Reuters) – The household savings stash built up during pandemic lockdowns looks to be mostly spent already, reinforcing fears that the growth rebound from the COVID-19 shock is already waning as the Federal Reserve gears up to reduce support.

If these ‘enforced’ savings windfalls have been drawn down already, more normal economic consumption patterns may return sooner than many had expected, even as variants of the coronavirus continue to cause disruption.

Sequencing either policy actions or investment decisions around this could be much trickier if the post-pandemic boomlet of the past year is over already.

Financial markets have been quick to switch gears during the turbulent 18 months since the pandemic unfolded – slashing world equity prices by a third in little over a month only to rebound dramatically from March last year in the middle of one of the deepest and shortest downturns in modern history.

That pricing of a vaccine-led rebound on the back of massive monetary and fiscal policy support saw a near unbroken 18-month equity rally that almost doubled global stock indices from the March 2020 nadir to this August, when they now stand some 25% above pre-pandemic levels.

The second quarter of 2021 saw annual economic and corporate earnings growth rocketing, alongside inflation rates.

But the big question now is whether markets have fully priced the rebound and are bracing for a slowdown having likely already passed ‘peak growth’, ‘peak earnings’ and even ‘peak inflation’.

Pent-up spending of so-called “excess savings” – accumulated largely by people working from home or furloughed in semi-closed economies – has been central to the quick recovery story. Just re-open economies and the cash gets splashed.

But the latest U.S. data shows household savings rates fell below 10% of disposable income in June for the first time since February 2020. At 9.4%, it was less than a third of the 34% peak seen in April last year and also down sharply from the reprise spike to 27% in March this year following new waves of COVID-19.

In dollar terms, those savings slid to less than $1.7 trillion – more than $4 trillion less than in March and just $300 billion above the average of the 12 months before the pandemic hit.

PEAK DISTRICT

Consumer spending – which makes up two thirds of U.S. economic activity and drove the heady 6.5% annualised U.S. second quarter output growth – slowed markedly as the third quarter kicked off. ‘Core’ U.S. retail sales that exclude food, energy, autos and building materials dropped a surprisingly large 1.0% in July.

Retail is not the only disappointment. The U.S. economic surprise index turned substantially negative last month for the first time in over a year and is now at its most negative since June 2020.

Indeed the aggregate surprise reading for G10 economies at large also turned negative this month to its lowest since June last year. China’s has been mostly negative for 6 months.

Equivalent household savings numbers for the euro zone and United Kingdom lag the United States but have shown similar patterns over the past year, meaning they likely also aped the U.S. decline of the second quarter.

UBS Global Wealth Management’s chief economist Paul Donovan sees the U.S. savings rundown as a gradual return to normal and a prime facie case for the Fed to dial back its bond buying.

For Donovan, the Fed’s emergency asset purchases were precisely to meet a surge in demand for cash reflected in those savings rates. But if consumers are now spending again, the Fed’s job is largely done and it should proceed with a tapering of bond buying that it’s likely to signal by yearend.

“U.S. growth is driven by consumption, funded by reduced savings rates, meaning slower demand for liquidity in the economy,” Donovan wrote. “Slowing the supply of liquidity to match is very reasonable.”

Reasonable or not, markets were less than thrilled at this week’s Fed meeting minutes showing such a taper is on the way.

Navigating a return to pre-pandemic norms was never going to be easy given the amount of stimulus absorbed by markets in the interim. But winding down Fed buying as growth ebbs from its peaks and amid persistent COVID-19 related disruptions mean the path could be bumpier than many had hoped.

Goldman Sachs economists this week cut their third quarter U.S. growth forecast to 5.5% from 9.0% due to problems related the virus’ more infectious Delta variant and other supply chain pressures – even though they see that slowdown as brief and revised up subsequent quarters.

And yet there are still gnawing fears the Fed may be too aggressive in removing support before the economy is fully through the pandemic and plenty of talk of a ‘hawkish error’.

That’s mainly why bond yields fell with stocks and commodity prices this week despite expectations of less Fed bond buying.

“Could the Fed be making a policy error here?” said VTB Capital strategist Neil MacKinnon. “It wants to taper, we’ve seen that message in the FOMC minutes – but could the Fed be tapering into a cyclical economic slowdown in the third and fourth quarters? There’s a risk of that.”

(by Mike Dolan. Additional reporting by Karin Strohecker and chart by Dhara Ranasinghe; Editing by Kirsten Donovan)

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