Zillow Market Pulse: May 29, 2020

May 29, 2020

A sharp fall in consumer spending coincided with a record increase in personal income and saving. New data makes it clear consumers are bracing for a slow economic recovery. And default rates on corporate debt could rise to new records in the next year.

• Consumer spending fell by a record amount in April, even as personal incomes rose

  • Real personal consumption expenditures and real disposable personal income fell and rose, respectively, in April at all-time record rates.
  • The personal saving rate rose 20.3 percentage points to 33%, the highest ever recorded.

• May consumer sentiment points to a pessimistic forward-looking outlook

  • The University of Michigan Index of Consumer Sentiment officially rose 0.7% in May from April.
  • The forward-looking Index of Consumer Expectations fell 6% on the month, more than was previously stated.

• Defaults on corporate debt expected to rise sharply over the next year

  • S&P Global Ratings Research expects default rates on speculative-grade corporate debt to increase to 12.5% by March 2021.
  • That would mean 233 companies will default on their debt.

 So what?

Consumer spending is the engine that drives the nation's largely service-based economy, so a record decline in April from March is obviously a bad sign, particularly when it is driven by a double-digit percent monthly drawdown in spending on services. The fact that a 13.2% fall in real overall spending came even as real personal income rose 13.4% over the same period suggests that the economy's recovery is going to be long, slow, and drawn out. Incomes rose well above consensus expectations in April, mostly thanks to stimulus checks distributed under the CARES act. But as job losses continue to mount, people have become very careful with their money, opting to put a much larger portion of their disposable income aside. The personal saving rate spiked to 33% in April, nearly twice any previously recorded level and up 20.3 percentage points from an already high level of 12.7% in March. Current policy states that the stimulus checks won't continue past this month, so forward-looking consumers clearly were thinking longer term as those payments arrived. The downshift in spending has also eased already light pressure on prices. The Personal Consumption Expenditure index (PCE) – the Federal Reserve's preferred measure of inflation – increased just 0.5% from a year earlier, the slowest annual pace since 1961 and well below the Fed's stated target pace of 2%. 

The final update to May's University of Michigan Consumer Sentiment Index was mostly equivalent to the advance estimate published two weeks ago, but did offer some slight differences. It still appears as though consumers are encouraged by the fact that large parts of the economy are primed to reopen in the near future, and hopeful that the recovery will begin soon. But they are also coming to grips with the fact that the recovery is likely going to be much longer than many initially expected. Today's release emphasized the latter point: The forward-looking index of consumer expectations fell 6% in May from April, notably more than the previously stated decline of 3.4%. In general, though, things appear to be stabilizing – consumer sentiment has remained more or less level in the past two months, and people are feeling better about current conditions than they were 8-10 weeks ago.

Thanks in large part to the Federal Reserve, the market for corporate debt has stabilized in recent months, prompting a surge in U.S. corporate bond sales. Since the start of the year, $1 trillion worth of investment-grade corporate debt sales have been made – far more activity than 2019, when the $1 trillion mark wasn't reached until November. But despite this increased action, it is widely accepted that a large portion of the market's participants remain in dire financial straits, even those able to raise additional funding. The risks are particularly pronounced with speculative-grade (aka "junk" or "high-yield") corporate debt, as the criteria for Federal Reserve support of those instruments are much more stringent — if available at all. Reports released today shed more light on the risks facing the companies issuing this kind of debt. S&P Global Ratings Research now officially expects the corporate default rate on speculative grade corporate debt to rise to 12.5% by March 2021 – 9 percentage points higher than the rate in March 2020, and higher than any level reached in the Great Recession. To put that in perspective, getting to that level would require 233 speculative-grade companies to default. The S&P report acknowledged the wide range of potential outcomes thanks to immense levels of uncertainty remaining throughout the economy, and also raised concern over offering more fiscal or monetary support to these companies whose core businesses were suffering heading into this crisis. In other bankruptcy news, a study conducted by a restaurant consultancy group stated that two-thirds of publicly-traded restaurants are at risk of going under, while gym chain 24 Hour Fitness is planning for a potential bankruptcy as well.

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