Something unprecedented happened in the immediate aftermath of the passage of the $2.2 trillion CARES act: as a result of the unprecedented transfer of wealth from the government to consumers in the form of countless stimulus measures, personal incomes soared and personal spending plunged (as the economy was largely shut down especially for spending on services), resulting in what we showed in May was an explosion in the annualized amount of Personal Savings, which soared by a mindblowing $4 trillion in May, rising from $2.1 trillion to $6.1 trillion...
... and accounting for a record 33% of disposable personal income!
As an aside, and as we pointed out back in May, contrary to economist expectations that "rational" consumers would promptly use this "one-time" universal basic income wealth transfer to pay down debt and get their financial affairs in orders, it appears that many splurged these government "stimmy checks" to buy stonks.
We bring all this up because the US savings rate, which has since dropped of substantially as a result of the gradual reopening of the economy as Americans spent much of their covid stimulus checks...
... is about to soar again when the latest personal spending and income data is released next month to account for the passage of the December $900 billion stimulus package, and then even more once Biden's various covid stimulus programs kick in.
In a note explaining why the US economy is likely to grow well above the bank's baseline assumption of 5.0% GDP (the strongest since 1984), the bank's head global economist Ethan Harris writes that "we have all become a bit numb to big numbers in the past year. Thus when the Biden administration announced its $1.9tn stimulus proposal, on top of $0.9tn already enacted, it triggered a relatively low-key response in the press and the markets. "Been there, done that" seemed to be the reaction."
According to BofA, the Biden stimulus proposal is in fact, "a very big deal" because if enacted, it would mean the recent stimulus packages match the stimulus last spring, despite the dramatic improvement in the economy. That's not all; restrictions on activity last year meant much of that stimulus went into savings, savings that can be deployed when the service sector reopens. As explained below, this creates major upside risks to our above-consensus forecast.
But first, a quick walk down memory lane.
- Last April, the consensus for 2020 GDP was for a -3.3% decline and by May that had worsened to -5.7%. Today, the consensus looks for 2021 growth of about 4.1% and BofA sees 5.0% growth. That would be the strongest year for US GDP growth since 1984. Again, this is without factoring in a second stimulus package.
- Last April, the consensus expected unemployment to hit 7.3% in the year ahead and by May that had risen to 9%. In reality, the unemployment rate has dropped to 6.7%, and the consensus expects the unemployment rate to fall to 5.3% by year-end.
The differences are equally stark in capital markets. On 23 March 2020, the S&P500 hit bottom, 34% off of its peak and most forecasters expected a slow, painful recovery at best. Nine months later the equity market is hitting all-time highs with no sign yet of leveling off. Similar stories apply to credit markets and risk appetite in general. These strong markets pre-date the "blue wave" and the $1.9tn proposal.
The outlook for the COVID crisis has also changed dramatically. Last spring and summer the end of the crisis was nowhere in sight. Most experts argued that a vaccine would likely be years away and many warned of a major resurgence of cases in the fall. Today, we are nearing the exit of the COVID cave, as increasingly more vocal Wall Street banks now believe. The vaccine is rolling out at an accelerating pace - and is expected to reach 1 million people per day - so that by the spring, hospitalizations - which just saw their fastest weekly drop on record - will have likely fallen by more than half. Herd immunity is likely sometime in the second half of this year.
Going back to the question of the wave of stimulus that is about to wash over the US economy, both the consensus and apparently Administration economists seem to be ignoring how COVID containment measures can delay the benefits of fiscal stimulus according to BofA. Last year, fiscal authorities were operating with one hand tied behind their back. No amount of fiscal stimulus was going to revive the service sector. The stimulus boosted goods spending and some of what would have been spent on services went to goods, but a major portion went into excess savings (see charts above). This is why the multiplier effects of the stimulus were unusually low.
How much excess saving was accumulated? Consider two simple calculations:
- First, comparing actual household savings to savings assuming a flat 8.25% saving rate, a cumulative $1.4tn in "excess savings" piled up on household balance sheets through November of last year.
- Second, comparing the monetary aggregate M2 to a baseline of steady 7% growth, there was $2.9tn of excess M2 balances-checking accounts, savings accounts, and so on-at the end of last year.
As BofA's Ethan Harris then writes, by the time the economy starts to reopen in the spring, those numbers could get considerably bigger. Specifically, BofA estimates that the $0.9tn package alone will add another $200bn or so to excess saving. If the $1.9tn is deployed quickly, total excess savings could approach $2tn by the spring!
The surge in savings will happen because, as Credit Suisse writes in a note on Friday, disposable "personal income will rise sharply in Q1 to just shy of its April peak after the $900bn relief bill (Figure 3). More stimulus under the Biden administration will push income even higher."
What happens then, and will all these government transfer payment and excess savings send the economy into overdrive? To Credit Suisse Biden's relief package - the third substantial stimulus in 12 months, following the $2.2tn CARES act and the $900bn bipartisan relief bill that passed in December - will lead to an even stronger economic tailwind, "perhaps blowing hardest just as normal social interactions are resuming while the pandemic ends." It's also why the bank just revised up its GDP growth forecasts this year higher from 5.5% (Q4/Q4) to 6.6%.
Perhaps it's not all that simple: as BofA's Harris explains, it is unfortunately hard to know how much of this spending power will be deployed when the economy reopens as we simply do not have any historical experience to draw on. However, "it does suggest that net stimulus today could be a good deal higher than the effective stimulus last summer" as much of it will be focused on serves as BofA explains next:
We expect there to be a rotation of the consumer basket towards experience-based spending from goods spending once the virus is sufficiently contained and people feel comfortable reengaging in COVID-sensitive activities (See Table 2 & Table 3 for a breakout of goods and services spending performance).
The timing will depend on a number of factors, including the potential spread of more contagious strains of the virus, the speed of vaccine distribution and the efficacy of vaccines.
If the US is able to sustain the current pace of vaccination (nearly 1mn per day), we think the turning point where consumers begin to shift money toward experiences will be mid-year. But there are two other important assumptions: what is the normalized level and how long does it take to return?
Focusing on services spending, we define normal as a return to pre-COVID level for “lost” spending, 50% overshoot for partial and complete offset for the full make-up spending categories (see Table 3). For argument’s sake, if we assume that the normalized level of services spending is reached by the end of 2022, it could require $2.9tn of spending (Chart 2,-Chart 4). This implies an average monthly growth rate of 1.1% mom SA for service spending as compared to the pre-COVID average monthly rate of 0.3% mom SA.
The above analysis only looks at the data on the aggregate. However, it is important to understand the distributional dynamics. We believe that much of the pent-up demand for services is among the higher-income population which, conveniently, is also where much of the excess savings is concentrated. Our view is supported by the fact that 1) the labor market has healed faster for the higher income population and 2) our BAC credit and debit card data suggest there is more room for recovery among high-income households, and 3) higherincome individuals tend to have a larger share of dollars allocated toward leisure activity in “normal” times, suggesting more pent-up demand from this group for services spend.
Of course, it will take some time to see how this plays out, but as we pointed out last week, we have already seen a significant boost to spending in the first half of January (see "Real-Time Card Spending Data Shows The Next Stimulus-Funded Buying Spree Has Arrived"). It will also take some time to figure out how much of the $1.9tn package is going to pass (consensus appears to believe that the final number will be around $1.1 trillion). And we will not know the lagged impact of fiscal stimulus on the service sector until it starts to reopen in the spring. Finally, the new variants of COVID could force new shutdowns, delaying the recovery.
The bottom line however is this: as BofA economist Michelle Meyer writes, "the need for massive “rescue package” could be fading" as her work "suggests there is already significant excess savings to be spent once the economy reopens. We estimate that spending on services was cut by about $900bn as a result of the pandemic but yet durable goods spending was only boosted by about $20bn. Contrary to popular belief, the money that otherwise would have been used for services spending was not just pumped into goods but instead much went to “unintentional” savings." Meanwhile savings were also boosted by extraordinary fiscal stimulus. The bottom line, as noted above, is that there could be $1.4tn in excess savings currently which is heading to $1.6tn in January following the $900bn stimulus package. And, if If Biden's $1.9tn stimulus is deployed quickly, total excess savings could approach $2tn by the spring! All that money could send the economy, and inflation, into overdrive.
The good news: as Harris summarizes, "what we feel confident about already is that there are considerable upside risks to our above-consensus forecast." That's also the bad news, because while the Fed is confident that there is absolutely no basis for expecting a surge in inflation, should US household savings soar to $2 trillion and then proceed to be aggressively spent in the coming months, it is a guarantee that prices will rise sharply in the second half of the year... which incidentally is when increasingly more Wall Street strategists expect a market crash (see ""6 Months For A Regime Change": Why One Strategist Believes The Market Will Crash In The Second Half Of 2021".)
Why? Because once even the Fed concedes that fiscal and monetary policies have unleashed inflation, the Fed will once again be boxed in, and will soon be forced to aggressively start tightening financial conditions, especially if inflation surges above the 2.5% tentative threshold that the Fed is indifferent toward as a result of last year's change to the Fed's average inflation targeting policy.
It's also why Wells Fargo strategist Chris Harvey said that the biggest "pain trade" for 2021 is an economic recovery:
“Funny enough, I think the big pain trade for a lot of people on the buy side is a recovery or a strong recovery, because many people haven’t traded in a post-recessionary environment. Many people have been trading in a low-growth or recessionary environment. And when growth is abundant, different things happen. The market rewards value and small caps and cyclicals and that could cause a lot of pain for much of the buy side, because they’re so steeped in that growth trade.”
In short, good news for the economy will be the worst possible news for risk assets.