MainStreet Macro: Are consumers still all right?

February 28, 2022 | read time icon 6 min

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While markets are reacting in real time to the recent developments in Russia and Ukraine, the effect of its uncertainty on the Main Street is tougher to discern. 

Closer to home, the Federal Reserve is expected to act next month to begin reining in inflation. That means rising interest rates and more uncertainty are on the horizon. So today we’re asking this question: Are consumers still all right?

There are three reasons to think they are.

Consumer Debt

Consumers have been the most consistent bright spot of the pandemic recovery, and big government spending is one key reason they’ve been able to weather the storm. 

Direct government payments, extended and more generous unemployment insurance, and tax credits all helped households stay in front of their expenses. Despite tremendous upheaval, people as a whole kept borrowing in check and upped their savings. In economic terms, low debt-to-income ratios and high saving rates haves marked most of the recovery.

Lately, however, there’s evidence that that the consumer’s fortress balance sheet is starting to weaken.

In the last three months of 2021, total consumer debt rose by more than $1 trillion from a year earlier to nearly $15.6 trillion. It was the highest level of debt ever recorded since the Fed began keeping records in 2003, and the biggest quarterly increase since the housing boom peaked in 2007.

In short, Main Streeters borrowed to keep up their spending. Credit card debt jumped by $52 billion, the largest quarterly increase in the data’s nearly 20-year history. 

It’s not necessarily bad news. Despite the jump in credit card use, debt levels are lower than they were before the pandemic. And consumers are still being frugal. Debt-to-disposable-income ratios are below pre-pandemic and historic levels.

Source: St Louis Federal Reserve Economic Research

Consumer debt is still in check.

Housing debt

I cut my teeth as an economist in the housing market. It remains one of my favorite segments of the economy for reading consumer trends. 

The housing market is highly sensitive to interest rates. And the sector sits at the biggest intersection of monetary policy and Main Street.

When interest rates are low, builders want to break ground on new houses and consumers want to buy them. This sets of a chain reaction of economic activity and home-related spending, from lumber to patio furniture.

Housing has been hot through most of the pandemic, and the prospect of higher mortgage rates failed to dent that market enthusiasm in January. Instead, buyers rushed to lock interest rates before their expected increase, according to the National Association of Realtors.

Yet, there are signs that housing’s lure is weakening. While sales were strong in January, they were down 2 percent from 2021 levels.

Buying a home will get more expensive this year. Mortgage rates are up about a percentage point from a year ago, to 3.89 percent. Prices are up, too, with a typical home costing 15.4 percent more than it did a year ago. And strong demand from buyers has driven already scant home inventory down 16.5 percent from the previous year – an all-time low.

The flip side is that rapidly rising appreciation means homeowners are quickly building wealth. U.S. home equity leapt nearly 20 percent in the third quarter from a year earlier.

Source: St Louis Federal Reserve Economic Research

Housing is good and getting better for sellers, bad and getting worse for buyers. 

Consumer Spending

Consumers are the crown jewel of the U.S. economy because they do one thing really well – spend.

Yet it matters not just how much consumers spend, but what they buy. A massive shift toward durable goods and away from in-person services contributed to rising inflation last year.

After a hiccup in December, retail sales jumped 3.8 percent in January. The big rebound was led by car sales. Like houses, cars are big-ticket items that are sensitive to interest rates.

The service sector didn’t fare as well. Spending at restaurants and bars was down nearly 1 percent on the month, likely due to renewed health worries as omicron hit Main Street.   

Another measure of service spending is the hard-hit airline industry. Air travel remains down by about 25 percent from pre-pandemic levels, as shown in the chart below.

In short, consumers still have a lot of runway to accelerate spending on services. The U.S. shift back to a service economy will relieve the demand pressure on goods that has contributed to inflation. And it should lift broader economic growth by supporting the service industry, which makes up the lion share of the economy.

Source:  St. Louis Federal Reserve Economic Research

Consumer spending on travel and other services isn’t yet back to normal.

My Take

The consumer is fine for now. However, with inflation on the front burner, new global events in the spotlight and federal relief spending in the rearview mirror, Main Street’s resilience shouldn’t be taken for granted.

The upshot is that while the economy will still chug along in 2022, growth is likely to be more modest than it was last year.