Americans Are Burning Through Their Extra Income

The party may be winding down for Americans who were spending freely over the summer.

Americans fueled robust economic activity in the three months through September even as their personal incomes and savings declined amid high inflation and elevated borrowing costs.

The U.S. economy expanded nearly 5 percent in the third quarter of 2023, much higher than the 2.1 percent growth seen in the previous quarter, the U.S. Bureau of Economic Analysis said on Thursday, on the back of robust spending by Americans. Economists had expected growth to come to between 4.5 to 4.9 percent.

Part of the reason the economy grew at such a healthy clip was due to the "increases in consumer spending," the Bureau of Economic Analysis said. However, there was evidence that household pocketbooks are softening.

Personal income increased to $199.5 billion in the third quarter, but that was less than the $239.6 billion in the second quarter, the BEA said. Disposable personal income increased to $95.8 billion, or 1.9 percent, in the third quarter, yet it was markedly down from the $296.5 billion, or 6.1 percent jump, in the second quarter.

Savings declined to $776.9 billion in the third quarter, compared with $1.04 trillion in the previous quarter. The personal saving rate—personal saving as a percentage of disposable personal income—was down to 3.8 percent in the third quarter, compared with 5.2 percent in the second quarter, the BEA noted.

Americans showed, however, they were still able to dip into their purses and fork out cash over the summer going to Taylor Swift concerts, dining out at restaurants and traveling for vacations bouying an economy above the headwinds of high prices and expensive borrowing costs.

"Consumers are handling the high rate environment pretty well," Mahir Rasheed, a senior economist at insurance firm Swiss Re, told Newsweek.

Despite rising prices constraining outlays, Americans spent on all manner of services and goods, splurged on cars and went to their doctors, consulting firm KPMG pointed out. Such economic momentum heading into the fourth quarter could help the world's fourth-largest economy avoid a recession, experts told Newsweek.

"The signs right now are not pointing to a recession in the near term based on how strong the consumer has been and how much momentum that gives us into the end of the year," said Yelena Maleyev, a senior economist at KPMG.

Over the last few weeks, there were signals that U.S. economic activity had been heating up.

In September, sales of new single-family homes soared more than 12 percent compared with August—to 759,000—and were up nearly 34 percent from a year ago, beating analysts' expectations.

Consumers also spent billions on retail and food services, and many employers were still keeping people working, strengthening their ability to spend, government data showed. Shoppers say they still plan to fork out cash for gifts during the holidays this year. And American Express reported that travel and entertainment spending remained robust on their cards, another indication that consumers were willing to put their money to luxurious use despite high prices.

But declines in personal incomes and a drop in savings in the third quarter raised the question of whether consumers are seeing their pots of cash start to dwindle heading into the holiday season and the new year.

Economists told Newsweek that there were some quirks that may explain why personal incomes fell compared to the previous quarter. Tax outlays came in later this year for some households, such as in California due to declaration of disasters, and forced people to make their payments later in the year than they would normally, registering a drop in their incomes now.

Looking ahead, with job gains showing some sluggishness and wage growth also slowing, Americans could soon become more cautious about their money.

"There's a lot of uncertainty," said Michael Pearce, an economist from Oxford Economics. "I suspect that will drive quite a sharp slowdown in consumer spending growth over the next two quarters."

On Thursday, unemployment claims slightly increased and the number of people relying on jobless benefits for longer at its highest since May. Analysts said that it showed that employers were pulling back on hiring.

But there were still no signs of massive layoffs, meaning Americans are still working, earning money and willing to keep spending, said Guy Berger, a former principal economist at LinkedIn.

"There's this positive feedback loop between people getting paid money to people spending money that then keeps people employed that exists in the economy," he told Newsweek. "It's a pretty powerful, virtuous cycle, and as long as that virtual cycle remains in place, and it still does, I think that the trajectory for real disposable income, personal income growth, will be decent."

Berger suggested that the decline in incomes could be a "one-off" and that with employment in the economy still solid, consumer spending will retain strength.

With employment claims ticking up, though, there are signs that the labor market was slackening, Wells Fargo economist Shannon Seery told Newsweek. Jobs openings are declining, hiring of temporary health workers has tempered and average work weeks have gone back to pre-pandemic levels, she pointed out, all evidence that the jobs market was moderating with implications for consumer spending over the coming months.

"We still are a bit pessimistic in terms of where growth is headed from here," she said in an interview. "It does come down to the fact that we're looking for further labor market moderation, which should show up then in income growth and weigh on consumer spending."

The BEA on Thursday reported that real disposable personal income, which is income adjusted for inflation, decreased by 1.0 percent in the third quarter compared to a rise of 3.5 percent in the previous quarter. Less favorable real income prospects will ultimately hit the consumer, Seery said

"The labor market piece that's key where you'd actually start to see some of this resiliency slip," she told Newsweek. "Excess liquidity is not as widespread as it was previously. Credit is obviously harder to obtain or more expensive. So, I think those factors that were supporting spending are quickly drifting to the wayside."

She added: "Income is really the key here. That's going to help households spend in the near term but then cause them to stop spending early to mid-next year."

Where is the economy headed

Economists told Newsweek that the U.S. economy may slowdown over the coming months amid the Fed's high interest rate environment and elevated prices proving tough to bring down. While inflation has fallen to 3.7 percent from its 40-year highs, it is still above the central bank's target of 2 percent.

The world's largest economy may avoid a recession in the fourth quarter and potentially beyond that—if consumer spending seen thus far carries over. There are risks—student loan payments have resumed, ballooning costs of insurance, rents and home prices are rising, all of which could eat away at the ability of Americans to maintain their disposable, luxury, spending, KPMG's Maleyev told Newsweek.

It was still unclear when that will happen, heading into the holiday season.

"We are in such a strong footing and and we have pretty good momentum entering the fourth quarter, and with it being the holiday season, people are wanting to reunite with family, they want to have the holiday parties," she said.

But that spending pace could cool and Americans could turn more frugal after the new year as the reality of tight credit and high prices hits.

"That new activity slowing down from these high interest rates and still high prices is going to cause that slowdown into next year, but we don't have a recession in the forecast," she said.

The key thing will be the jobs situation, Berger pointed out, and whether employers pull back on hiring substantially which could scare consumers to sharply reduce spending. "There are always risks out there and the risks are probably elevated right now, but there's a lot of resilience still built in here that in the near term keep things afloat," he told Newsweek.

Pearce from Oxford Economics said that the economy will technically avoid a recession but the challenge is inflation remains elevated.

"Chances are the decline in inflation is going to be more gradual than previously anticipated, so rates are gonna need to remain on hold for longer and there's still a chance of additional rate hikes," he told Newsweek.

That environment means there was a good chance of at least one negative quarter of economic activity, he said, but less chance of the "R" word coming to fruition.

"I think it makes more sense to think about this as a sharp slowdown rather than there's an outright recession," he told Newsweek.

Where does that leave the Fed as they gather next week to decide on whether to hike rates above the 5.25 to 5.5 percent current range, the highest it's been in two-decades?

"For the Fed, honestly, I think they're pretty happy with where things stand right now," Swiss Re's Rasheed said. "They're happy with the fact that tightening is feeding into the system, but it hasn't necessarily been recessionary."

Policymakers will be paying attention to some of the risks that are percolating, such as fighting in the Middle East that could inflame energy prices, and they may need to remain nimble.

The expectation was Fed chair Jerome Powell and his colleagues would hold rates in November but communicate a possible hike down the line.

"The war against inflation is not won," Maleyev said.

Certain indications are that inflation may be coming down, she pointed out, but risks abound, especially as consumers have shown their willingness to see through higher prices, buying homes and are ready to splurge on holiday gifts.

"I am really worried about housing," Maleyev told Newsweek. "So, the Fed doesn't want to take their eye off the goal here when it comes to fighting inflation and they know they might have to just keep rates higher for longer."

Update 10/26/23, 18:45 p.m. ET: This story has been updated to add quotes, background and context.