Dwindling savings could ruin hopes for a soft-landing in the markets.

Dwindling savings could ruin hopes for a soft-landing in the markets.

The Shrinking Cash Piles: Will Excess Savings Trigger an Economic Slowdown?

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With hopes for a soft landing in the economy, markets have been rallying, both in bonds and equities. However, there might be a curveball waiting in the wings that could dampen this bullish sentiment – the sharp drawdown of excess savings accumulated during the COVID-19 pandemic.

Throughout the lockdowns and government stimulus of 2020-2021, households built up significant cash piles, which were seen as a buffer against a deep recession. Analysts and central bankers sang praises of these excess savings. But now, high inflation and rapidly rising interest rates are quickly eroding these savings cushions.

According to the San Francisco Federal Reserve’s estimate, U.S. excess savings have dropped from approximately $2.1 trillion in August 2021 to around $500 billion. In Europe, Deutsche Bank reports that excess savings in countries like Sweden, which is grappling with a property slump, have also dwindled. British households withdrew money from savings at an unprecedented pace in May, and the government’s Office for Budget Responsibility predicts a savings ratio of zero by the end of the year, down from almost 25% in 2020.

While the depletion of excess savings might not directly cause a recession due to tight job markets, it could trigger a spending downturn that leads to the typical economic spiral of falling business investment and high unemployment. As a result, some investors are turning to government bonds as a safe haven, while avoiding consumer stocks and high-yield credit assets.

Janus Henderson multi-asset portfolio manager, Oliver Blackbourn, emphasizes the importance of domestic consumption in economies such as Britain, the United States, and the euro zone. He warns that if consumer spending falls apart, these economies can become very fragile very quickly.

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Running Out

The definition of excess savings may differ, but analysts generally agree that it refers to savings that went beyond trend levels during the pandemic. Cardano chief analyst Shweta Singh predicts that U.S. pandemic excess savings will likely be depleted by the end of this year, coinciding with the end of pandemic-era student loan repayment relief, which will further burden consumers.

In Europe, excess savings have not been spent to the same extent. Euro zone consumers reportedly saved an extra 1 trillion euros ($1.10 trillion) during the pandemic, but a strong savings culture might prevent them from spending this surplus on non-essential items like clothes or holidays.

Zurich Insurance Group’s chief market strategist, Guy Miller, believes that Europe is a bit further behind, but a similar dynamic is likely at play, indicating that discretionary spending has reached its peak.

Caution

Business activity data suggests that the previously resilient services sector is now weakening. Ryanair warns of low demand for winter holidays, and JPMorgan CEO, Jamie Dimon, notes that U.S. consumers are gradually depleting their cash buffers. Unilever, the maker of Ben & Jerry’s ice cream, originally identified $1.5-$2 trillion in excess household savings in China that could boost sales. However, they now report a “very cautious” Chinese consumer.

Eren Osman, managing director of wealth management at Arbuthnot Latham, advises caution regarding shares in the consumer discretionary sector, such as car makers, as well as businesses selling consumer staples like cleaning products and food. He predicts that the “pinch on disposable incomes” resulting from dwindling consumer savings will impact the profit margins of consumer businesses.

Janus Henderson’s Oliver Blackbourn shares a similar sentiment and recommends caution with smaller stock indices that are more exposed to domestic consumers, such as the U.S. Russell-2000 and London’s FTSE-250. He points out that the Russell index tends to underperform the larger S&P 500 during downturns, according to Goldman Sachs. The FTSE-250, dominated by UK banks, consumer discretionary, and industrial stocks, raises similar concerns.

Zurich’s Guy Miller highlights the high exposure (35% for the U.S. and 31% for Europe) of high-yield credit indices to consumer cyclical and non-cyclical names, further advising caution in these areas.

Buy Govvies

Anticipating a drain on savings that could accelerate recessions, investors are favoring safe-haven government bonds. Legal & General fixed-income manager, Simon Bell, explains that dwindling consumer savings influence his preference for government bonds of countries like Britain and Australia, where shorter mortgage terms make households rate sensitive. He believes that higher housing costs combined with weaker consumer spending could lead central banks to believe they have done enough in terms of stimulus.

As Britain’s savings are expected to run down just as fixed-rate mortgage costs rise, households refinancing loans taken out during years of low interest rates with more expensive debt will face additional pressure. The Bank of England forecasts mortgage repayment increases of at least 500 pounds ($641.25) for 1 million households by 2026.

Investors primarily focus on job markets when attempting to time recessions, as they remain strong in developed economies. However, weaker consumer spending may help cool inflation, leading to a preference for longer-term bonds to take interest rate risks.

($1 = 0.7797 pounds) ($1 = 0.9127 euros)

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