Unless explicitly stated, views expressed do not constitute official PIMCO views.

How Long and How Much Will U.S. Consumption Bolster the Economy?

In the face of tighter monetary policy, the U.S. economy has proved remarkably resilient over the last year. We believe this is largely due to the relative stability of real consumption growth against what was until recently contracting real incomes. A low savings rate has helped smooth consumption patterns as price levels surged and wage adjustments lagged.

At roughly 4.5%, the U.S. savings rate is well below the pre-pandemic average of 7.5% to 8% (according to the U.S. Bureau of Economic Analysis). From the 1970s to today, the only period characterized by a lower savings rate was 2005-2007, when many consumers were overleveraged with housing and related debt.

A key question for the outlook is whether and how long the current consumer savings rate is sustainable, and that question is directly related to just how much excess savings consumers are currently holding as a direct or indirect result of the pandemic.

Pandemic-related government support drove a substantial increase in economy-wide disposable income at a time when business closures and social distancing to mitigate virus spread led to a significant drop in household spending. As a result, U.S. aggregate personal savings rose rapidly, far beyond its pre-pandemic trend, and in spite of higher prices, this glut of excess savings is likely supporting current spending.

However, estimates for the current level of household excess savings and for how quickly it could be "drained" vary substantially; they depend on the assumed trend pace of saving, which is highly uncertain. Studies based on various trend estimates suggest post-pandemic peak economy-wide excess savings in the U.S. was likely between $2 trillion and $2.5 trillion. The current level of excess savings appears substantially lower - either largely drawn down, or likely to be by early next year. The extent and timing of the drawdown in excess savings is important for the U.S. consumption outlook: As macro theory says, consumers are likely to adjust higher their rate of savings as their excess stock declines.

The U.S. economic outlook, and specifically the outlook for consumption, is correspondingly sensitive to the outlook for the savings rate. From a purely accounting perspective, a 1 to 2 percentage point rise in the savings rate over the next year is enough to produce forecasts of contracting real consumption and contribute to an outlook for mild economic recession. However, there are several reasons to reassess that outlook:

• First, after drifting higher earlier this year, the U.S. savings rate has recently moved sideways. Of course, the data can be revised (and savings data are notorious for revision), but the fact that the savings rate hasn't continued to edge higher as excess savings dwindles, and ahead of the known restart of student loan payments (which we estimate will reduce annualized discretionary income by $100 billion), is puzzling. Perhaps consumers just have more excess savings than implied by the widely followed estimates. If this is correct, it suggests that low savings rates can be sustained for a while longer.
• Second, household wealth has also grown tremendously since the pandemic, partially driven by large increases in home values. To be sure, consumers' ability to draw on that wealth has been limited by their ability to access bank equity lines of credit, and banks are tightening credit standards for many consumers. However, consumers may be finding other ways to re-leverage, such as via holding higher credit card balances - something that banks and credit card companies have highlighted recently - as a way to monetize the wealth.
• Third and related, debt service ratios (DSRs) aren't rising as fast as in past rate-hiking cycles, limiting the consumer feed-through of higher rates. The pandemic produced material housing market turnover as people migrated out of cities, contributing (along with mortgage refinancing) to the currently elevated stock of low-fixed-rate mortgages, which has depressed the household DSR despite the Federal Reserve's increase in interest rates. It's possible that these low and stable interest payments give consumers more confidence to leverage up in other ways.

Despite all of these factors that may support higher consumption, we also see some cautionary developments. In particular, according to Equifax, credit delinquencies are starting to rise in various segments, including auto loans, credit cards, and consumer installment loans, and banks are tightening lending standards for consumers, particularly consumers with lower income and low credit ratings. During their most recent quarterly earnings call, senior leaders of a major U.S. retailer told investors that they "experienced an increased rate of delinquencies within the credit card portfolio across all stages of aged balances." Rising delinquencies are likely concentrated in the lowest-income households with depleted savings. Despite a historically tight labor market and stronger wage gains for lower-wage jobs, many of these households were likely forced by high inflation to overleverage to maintain their standard of living. Still, despite the potential early signs of weakness, trends outside of the lowest-income groups appear to reflect a normalization after very low post-pandemic delinquency rates. The increasing bifurcation between the low income households and their higher-earning peers has meant that the weakness hasn't yet affected the average economy-wide consumption statistics.

What does all of this mean for Fed policy? As we've said in recent notes, a U.S. consumer with more room to run lowers the near-term recession odds. While this is positive for households on average, it likely also means that the overall economy, labor markets, and underlying inflation might not be cooling as fast as Fed officials would like. While the economy is still likely to face various headwinds in the back half of this year, which, coupled with deteriorating credit for lower-income households, will help cool things down, recent data suggest that the consumer (and the economy) could remain surprisingly resilient in the face of higher interest rates. This in turn means that it's not unthinkable to envision the Fed not only staying on hold, but announcing further rate hikes next year.

This report, like future reports, summarizes the vast array of data analysis that we do at PIMCO. Please don't hesitate to ask us about the underlying data and analysis. If you would like to reach out, please email [email protected].

For regular insights on U.S. policy via email, please write to [email protected] and ask to receive the Washington Watch.

IMPORTANT NOTICE
Please note that this communication contains the opinions of the manager as of the date sent and may not have been updated to reflect real time market developments.

All investments contain risk and may lose value.

Statements concerning financial market trends or portfolio strategies are based on current market conditions, which will fluctuate. There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors and each investor should evaluate their ability to invest for the long term, especially during periods of downturn in the market. Investors should consult their investment professional prior to making an investment decision. Outlook and strategies are subject to change without notice.

This material contains the current opinions of the manager and such opinions are subject to change without notice. This material is distributed for informational purposes only and should not be considered as investment advice or a recommendation of any particular security, strategy or investment product. Information contained herein has been obtained from sources believed to be reliable, but not guaranteed.

PIMCO as a general matter provides services to qualified institutions, financial intermediaries and institutional investors. Individual investors should contact their own financial professional to determine the most appropriate investment options for their financial situation. This is not an offer to any person in any jurisdiction where unlawful or unauthorized. | Pacific Investment Management Company LLC, 650 Newport Center Drive, Newport Beach, CA 92660 is regulated by the United States Securities and Exchange Commission. | PIMCO Europe Ltd (Company No. 2604517, 11 Baker Street, London W1U 3AH, United Kingdom) is authorised and regulated by the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN) in the UK. The services provided by PIMCO Europe Ltd are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Europe GmbH (Company No. 192083, Seidlstr. 24-24a, 80335 Munich, Germany), PIMCO Europe GmbH Italian Branch (Company No. 10005170963, Corso Vittorio Emanuele II, 37/Piano 5, 20122 Milano, Italy), PIMCO Europe GmbH Irish Branch (Company No. 909462, 57B Harcourt Street Dublin D02 F721, Ireland), PIMCO Europe GmbH UK Branch (Company No. FC037712, 11 Baker Street, London W1U 3AH, UK), PIMCO Europe GmbH Spanish Branch (N.I.F. W2765338E, Paseo de la Castellana 43, Oficina 05-111, 28046 Madrid, Spain) and PIMCO Europe GmbH French Branch (Company No. 918745621 R.C.S. Paris, 50-52 Boulevard Haussmann, 75009 Paris, France) are authorised and regulated by the German Federal Financial Supervisory Authority (BaFin) (Marie- Curie-Str. 24-28, 60439 Frankfurt am Main) in Germany in accordance with Section 15 of the German Securities Institutions Act (WpIG). The Italian Branch, Irish Branch, UK Branch, Spanish Branch and French Branch are additionally supervised by: (1) Italian Branch: the Commissione Nazionale per le Società e la Borsa (CONSOB) (Giovanni Battista Martini, 3 - 00198 Rome) in accordance with Article 27 of the Italian Consolidated Financial Act; (2) Irish Branch: the Central Bank of Ireland (New Wapping Street, North Wall Quay, Dublin 1 D01 F7X3) in accordance with Regulation 43 of the European Union (Markets in Financial Instruments) Regulations 2017, as amended; (3) UK Branch: the Financial Conduct Authority (FCA) (12 Endeavour Square, London E20 1JN); (4) Spanish Branch: the Comisión Nacional del Mercado de Valores (CNMV) (Edison, 4, 28006 Madrid) in accordance with obligations stipulated in articles 168 and 203 to 224, as well as obligations contained in Tile V, Section I of the Law on the Securities Market (LSM) and in articles 111, 114 and 117 of Royal Decree 217/2008, respectively and (5) French Branch: ACPR/Banque de France (4 Place de Budapest, CS 92459, 75436 Paris Cedex 09) in accordance with Art. 35 of Directive 2014/65/EU on markets in financial instruments and under the surveillance of ACPR and AMF. The services provided by PIMCO Europe GmbH are available only to professional clients as defined in Section 67 para. 2 German Securities Trading Act (WpHG). They are not available to individual investors, who should not rely on this communication. | PIMCO (Schweiz) GmbH (registered in Switzerland, Company No. CH-020.4.038.582-2, Brandschenkestrasse 41 Zurich 8002, Switzerland). The services provided by PIMCO (Schweiz) GmbH are not available to retail investors, who should not rely on this communication but contact their financial adviser. | PIMCO Asia Pte Ltd (Registration No. 199804652K) is regulated by the Monetary Authority of Singapore as a holder of a capital markets services licence and an exempt financial adviser. The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Asia Limited is licensed by the Securities and Futures Commission for Types 1, 4 and 9 regulated activities under the Securities and Futures Ordinance. PIMCO Asia Limited is registered as a cross-border discretionary investment manager with the Financial Supervisory Commission of Korea (Registration No. 08-02-307). The asset management services and investment products are not available to persons where provision of such services and products is unauthorised. | PIMCO Investment Management (Shanghai) Limited. Office address: Suite 7204, Shanghai Tower, 479 Lujiazui Ring Road, Pudong, Shanghai 200120, China (Unified social credit code: 91310115MA1K41MU72) is registered with Asset Management Association of China as Private Fund Manager (Registration No. P1071502, Type: Other). | PIMCO Australia Pty Ltd ABN 54 084 280 508, AFSL 246862. This publication has been prepared without taking into account the objectives, financial situation or needs of investors. Before making an investment decision, investors should obtain professional advice and consider whether the information contained herein is appropriate having regard to their objectives, financial situation and needs. To the extent it involves Pacific Investment Management Co LLC (PIMCO LLC) providing financial services to wholesale clients, PIMCO LLC is exempt from the requirement to hold an Australian financial services licence in respect of financial services provided to wholesale clients in Australia. PIMCO LLC is regulated by the Securities and Exchange Commission under US laws, which differ from Australian laws. | PIMCO Japan Ltd, Financial Instruments Business Registration Number is Director of Kanto Local Finance Bureau (Financial Instruments Firm) No. 382. PIMCO Japan Ltd is a member of Japan Investment Advisers Association, The Investment Trusts Association, Japan and Type II Financial Instruments Firms Association. All investments contain risk. There is no guarantee that the principal amount of the investment will be preserved, or that a certain return will be realized; the investment could suffer a loss. All profits and losses incur to the investor. The amounts, maximum amounts and calculation methodologies of each type of fee and expense and their total amounts will vary depending on the investment strategy, the status of investment performance, period of management and outstanding balance of assets and thus such fees and expenses cannot be set forth herein. | PIMCO Taiwan Limited is an independently operated and managed company. The reference number of business license of the company approved by the competent authority is (112) Jin Guan Tou Gu Xin Zi No. 015 . The registered address of the company is 40F., No.68, Sec. 5, Zhongxiao East Rd., Xinyi District, Taipei City 110, Taiwan (R.O.C.), and the telephone number is +886 2 8729-5500. | PIMCO Canada Corp. (199 Bay Street, Suite 2050, Commerce Court Station, P.O. Box 363, Toronto, ON, M5L 1G2) services and products may only be available in certain provinces or territories of Canada and only through dealers authorized for that purpose. | No part of this publication may be reproduced in any form, or referred to in any other publication, without express written permission. PIMCO is a trademark of Allianz Asset Management of America LLC in the United States and throughout the world. ©2023, PIMCO.

AID161784