US consumer sentiment gains mean spending likely to defy declining wealth

U.S. consumers' outlook on the economy is improving even as household wealth drops, suggesting pent-up savings will continue to fuel broader spending.

The University of Michigan consumer sentiment index bounced to 58.1 in August, up 6.7 points from July after collapsing to an all-time low in June. The result shows consumers are taking a rosier view of the economy and their own plans to spend even as inflation remains near its 40-year high.

A collapse in sentiment coincided with a drop in real personal consumption expenditures — what households spend on goods and services — following a boom in spending once pandemic lockdowns ended. Even so, expenditures are still growing on a year-over-year basis, at 2.2% in July, as consumers are drawing down their savings to continue spending. That trend will continue, with S&P Global Market Intelligence economists forecasting household savings to remain below the pre-pandemic level of 7%-9% through most of 2023, as consumers continue to spend down the cash stockpiled during the pandemic.

"What we're seeing right now is people are using lagged gains in income and wealth to continue spending," said Akshat Goel, senior U.S. economist at S&P Global Market Intelligence.

Further gains in sentiment will continue to support spending, especially as gas prices, which mirror rises and falls in sentiment, retreat from their recent highs.

Sentiment and spending trend

Historically, an improvement in sentiment does not mean consumer spending will immediately strengthen. Spending is typically determined by long-term fundamentals like wealth and income, whereas sentiment is closely correlated with more immediate factors like swings in the price of gas. But with inflation a key factor in holding back growth in personal consumption, the sentiment survey is a more useful indicator of the health of the consumer than it would normally be.

"Where sentiment has a lot of value is not during normal times, when volatility is low and when the economy is just chugging along as expected. Where they are useful is when the wheels fall off the truck, like COVID, like the great financial crisis. That's when we get a lot of value from high-frequency data," said Michael Zdinak, U.S. economics director at S&P Global Market Intelligence.

Consumer confidence took a battering in the face of upward pressure on prices caused first by the disruption of COVID-19 and then worsened by sanctions on Russian exports of gas and oil.

"If you think a recession is around the corner, you're going to cut back," said Dana Peterson, chief economist with nonprofit business membership and research group The Conference Board. "It's not just food and energy that's troubling the consumer in terms of higher prices, it's just about everything."

Households dip into savings to fund spending

Wealth has historically been a better gauge of consumption than sentiment. That relationship broke down during COVID-19 as lockdowns reduced spending but boosted household wealth as people put more of their income into the bank.

The saving rate — calculated as the percentage of disposable income that is saved rather than spent — surged from a pre-pandemic level of 8.3% to a peak of 33.8% with U.S. households building up a treasure trove of $2.5 trillion in excess savings.

The savings rate tanked as the economy reopened and enabled spending on services while spiking inflation meant real incomes became negative for many. At 5%, the savings rate is significantly lower than it was before COVID-19 rocked the U.S. economy.

Consumption would typically suffer with the rate of savings falling and real household wealth shrinking. Market Intelligence forecasts, however, that households buoyed by the expectation of lower prices will fall back on the excess savings to keep spending through 2023.

Inflation peaking and gas price breakdown

The consumer price index rose 8.5% year over year in July, lower than June's four-decade high of 9.1%. That latest reading suggested prices may be at or near the peak.

Market Intelligence economists expect consumer gas prices will fall further as economic weakness in Europe and China reduces demand for fuel. This should result in a continual increase in the consumer sentiment survey index.

"A strong dollar, declining oil prices and a cooling in demand, following fiscal and monetary tightening earlier in the year, are all helping to restrain price pressures," said Mark Dowding, chief investment officer of BlueBay Asset Management.

The upward shift in sentiment will support spending in the short term even as Americans have less wealth to rely on. Yet the reality of more expensive gas, food and other goods means that people are still being squeezed and a bump in the growth rate of consumer spending is unlikely.

"What does matter for spending, and for how people feel about the economy, is not necessarily the level [of the sentiment survey], but the change in direction," Zdinak said.