The Checkbook Disconnect

HIGHLIGHTS:

• US consumers are sitting on over $2 trillion in excess savings and continue to spend despite low sentiment numbers.
• The all-important retail sales gauge saw a 0.7 percent increase in July, excluding autos and gas.
• A resilient consumer remains a bright spot for data, while the business activity surveys are showing continued weakness.
• Breakeven rates in the bond markets indicate inflation may tame towards 4 percent over the next few years.

An interesting dynamic is building in the US: Consumer sentiment is at record lows, but consumers continue to spend. US residents are sitting on more than $2 trillion in excess savings as balance sheets were bolstered by a resilient economy, strong employment, and stimulus despite a retrenchment during the pandemic. Even as other economic reports disappoint, consumption has remained resilient. The most recent retail sales report saw a revised jump in June sales while July plateaued, with gasoline and auto purchases detracting from the bottom line. Excluding autos and gasoline, sales did better than expected, rising 0.7 percent in July.

Why is the amount consumers spend such a big deal? US GDP growth relies on purchases, with more than two-thirds of GDP coming from consumer spending. As gasoline prices have fallen from their summer highs, sentiment may rebound somewhat. This is one point of optimism investors are looking for in the current economic landscape. That is countered by recent data from the US Purchasing Managers’ Index, which contracted for the second straight month and showed its weakest reading in more than two years. The S&P Global Flash Composite version of the gauge dropped to 45 in August—its lowest level since May 2020—after sliding almost three points in July. A survey reading below 50 indicates a contraction in private business activity.

Inflation and the hawkish rate policy from the Fed and central banks across the globe are influencing many of these disappointing reports. Regarding inflation, we believe that headline price increases may have reached their peak and should move downward gradually over time—though the rate will likely stay elevated. Breakeven rates, or the implied forecasts for inflation within the bond markets, indicate that inflation will remain around four percent over the next few years. Another spike may occur, depending on wage increases and the potential for that theoretical spiral. The base case indicates that the Fed may take a break from rate hikes at the beginning of next year but could need to raise rates again if inflation remains stubborn.

For now, however, the financial markets are waiting for that trend. As developments in inflation or economic data begin to materialize, investors can have more certainty whether an economic slowdown is on the horizon or will be avoided. After a nice earnings season, stocks seem poised to continue their rebound but may need a further catalyst to break out of the current trading range.

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