Stock photos by Vecteezy

Conventional recessions usually have their beginnings in the consumer sector as weakening incomes and rising inventories result in a widespread slowdown. Early indications are that this typical pattern is currently underway. In 2021, consumers were flush with cash as a result of various stimulus programs and the national savings rate surged because there was little opportunity to spend during the depths of the COVID-19 shutdown. As the COVID-19 restrictions lifted, a more balanced growth pattern emerged, including the consumption of services, and, as expected, the savings rate returned to pre-COVID-19 levels. 

Figure 1 U.S. Savings Rate Decline

(Click on image to enlarge)

Source: FRED

Stimulus payments dropped dramatically from $US 2.8T in 2021 to $US600B and the consumer savings rate plunged from nearly 25% in mid-2021 to 6.4%today. (Figure 1). The rapid bounce back in consumption soon proved to be the result of a “sugar high”. But now that the stimuli programs have, for the most part, ended and we need to examine what will be the force to maintain consumption going forward. There is a marked slowdown in personal income growth, the backbone of the economy. In nominal dollar terms, there has been a steady decline in the month-over-month growth in income such that by January nominal incomes remain flat. Real wages, discounted for the effects of inflation, have been declining steadily with January’s rate coming in at minus 0.5%. Put differently, the consumers’ capacity to maintain spending patterns is being eroded from two perspectives: stagnant wages and rising inflation (Figure 2).  

Figure 2 Monthly Changes in Personal Income

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Source: Bureau of Economic Analysis

At the same time, there is a slow, but steady, build-up in inventories, (Figure 3). January 2022 inventories grew by 1.7% over the previous month and this accumulation rate may well continue given the slow down in personal incomes. The inventories accumulated at the end of 2021 resulted from a miscalculation on the part of producers and distributors and must be subtracted from GDP in 2021Q1. 

Figure 3 Growth in Retail Inventories, ex-auto, m/m

Now, there is a major exogenous factor that will contribute to the coming recession--- the surge in oil prices. Given that there is no short-term substitute for oil, the additional expenditures at the gas pump means there is less income to spend on non-energy goods and services. In time, this deflationary effect on consumption will be a significant factor in holding back future growth. Hence, the Fed’s strategy of steadily pushing up the funds rate comes at the least inopportune moment. More to the point, it is entirely likely that central banks will be forced to act cautiously on rate hikes under these circumstances.