A recent study by the Federal Reserve Bank of San Francisco highlights a troubling trend for middle- and lower-income Americans: they are depleting their disposable cash reserves at an alarming rate. According to the research, these households are now on track to have less liquid cash than they were expected to have before the COVID-19 pandemic disrupted the U.S. economy. This development raises concerns for traders and investors, as the financial instability of a significant portion of the population could have broad implications for consumer spending and market dynamics.
The study, published by the San Francisco Fed, reveals that while the top 20% of income earners experienced a sharp increase in their liquid assets—such as cash and funds in savings, checking, and money market accounts—during 2020 and early 2021, their financial cushions have since diminished. Currently, their liquid assets are approximately 2% below where they would have been without the pandemic’s impact.
The situation is more dire for the bottom 80% of households by income. These households saw only modest gains in their liquid assets during the same period, and they have already exhausted much of their excess savings. As a result, their liquid assets are now about 13% lower than the pre-pandemic projection. This decline is especially concerning for investors, as it suggests that a large segment of the population may struggle to maintain current levels of consumer spending, a key driver of economic growth.
The study also points to a rise in credit card delinquencies among middle- and lower-income families. These delinquencies have increased earlier, more quickly, and to “notably higher” levels than those seen among higher-income families. The rising credit stress among these households not only indicates financial strain but also poses a risk to future consumer spending, which could dampen overall economic growth.
Economists Hamza Abdelrahman, Luiz Edgard Oliveira, and Adam Shapiro, who authored the study, emphasize the potential risks: “Smaller financial cushions and heightened credit stress for households at the bottom 80% of the income distribution pose a risk to future consumer spending growth.”
Consumer spending, which constitutes approximately two-thirds of U.S. economic output, has remained resilient even as the Federal Reserve aggressively raised interest rates in 2022-23 to combat inflation. This resilience has fueled optimism among policymakers that they can achieve a “soft landing”—lowering inflation without triggering a recession or a sharp rise in unemployment.
However, recent economic data suggest that this optimism may be premature. The July jobs report indicated a rise in the unemployment rate to 4.3%, the highest since the pandemic, and a slowdown in hiring. Additionally, the pace of consumer spending growth has decelerated, averaging just 0.3% on a month-to-month basis in the three months through June, the slowest pace in over a year.
For traders and investors, these developments are crucial. The shrinking financial cushions among a vast majority of Americans could signal a slowdown in consumer-driven economic activity. Furthermore, the rise in credit stress among middle- and lower-income families could exacerbate this trend, potentially leading to weaker-than-expected earnings for consumer-facing companies.
Key Takeaways for Traders and Investors:
- Diminished Cash Reserves: The bottom 80% of American households are seeing a sharp decline in liquid assets, now 13% below pre-pandemic projections. This reduction in disposable cash could weaken consumer spending, a critical component of economic growth.
- Rising Credit Stress: Increased credit card delinquencies among middle- and lower-income families signal growing financial strain, posing additional risks to consumer spending and overall economic stability.
- Economic Indicators: A slowdown in hiring and a deceleration in consumer spending growth raise concerns that the Fed’s aggressive interest rate hikes may be cooling the economy more than anticipated, which could impact market performance.
- Soft Landing at Risk?: While policymakers remain hopeful about achieving a soft landing, recent data suggest that the economy may be slowing down, potentially challenging this optimistic outlook.
Conclusion
As financial conditions deteriorate for a large portion of the U.S. population, traders and investors should closely monitor consumer spending trends and credit market conditions. These factors will be critical in assessing the sustainability of economic growth and the potential impacts on market performance. While the Fed aims to balance inflation control with economic stability, the current dynamics suggest that achieving this balance may be more challenging than anticipated.
