Big Banks: High Interest Rates and Sticky Inflation Haven’t Dented Consumer Spending

Even after two years of elevated inflation and interest rates, US consumers remain ready and able to spend.

That’s the interpretation the country’s biggest banks offered in their first-quarter earnings calls. It’s good news for the economy. From their vantage point, the biggest banks can paint a picture of consumers’ ability to spend, how much cash they have on hand, how much debt they carry, and how likely they are to repay that debt. Analysts use that data for clues about where the economy might be headed.

A weakening consumer would be bad news, but big banks don’t see that as their base case, even if economic growth slows or the labor market weakens. Consumers are “generally healthy and resilient,” Morningstar analysts Maoyuan Chen and Dev Patel say. “Unemployment is very low. Home prices are up. Stock prices are up … higher-income folks still have more money, they’re still spending it. So whatever happens, the customer is in pretty good shape,” said JPMorgan JPM CEO Jamie Dimon during the bank’s earnings call last week.

Spending Rose In the First Quarter

Spending rose in the first quarter at the country’s biggest banks, including Bank of America BAC, JPMorgan, Wells Fargo WFC, and Citigroup C. This is a sign that consumers remain confident about their economic prospects despite headwinds like high interest rates and inflation.

“Spending patterns of consumers using our debit and credit cards remain generally consistent and continue to grow year over year,” Wells Fargo CEO Charles Scharf said on an earnings call last week. He added that the bank continues to see strength in the US economy. At JPMorgan, credit and debit card spending was up 9% year over year in the first quarter. At Bank of America, credit card spending rose 12% over the fourth quarter but was down on an annual basis. At Citigroup, credit card spending rose 3% on an annual basis.

Pandemic Distortions Unwinding

In the wake of the covid-19 pandemic, strong consumer spending has been a key tailwind for the stock market and the economy. Analysts say that dynamic is beginning to shift as pandemic-era distortions like excess savings and a rotation away from spending on services fade. Still, consumers have weathered the storm so far.

For example, consumer debt as a portion of household income is rising, but households have handled the extra pressure thanks to a strong jobs market and wages keeping pace with inflation. Morningstar analysts point out that the household debt service ratio was 9.8% in the fourth quarter of 2023. That’s higher than the previous two quarters, but still “quite low,” they say.

The analysts add that consumer spending and credit card losses are returning to pre-pandemic trends, signaling the boost from pandemic stimulus and excess savings has largely worked its way out of the economy.

On the other hand, some changes in consumer behavior indicate weakness. Morningstar analysts point out that shoppers are shifting spending from discretionary categories like luxury goods and restaurant meals to core items like groceries and healthcare products. Households being less willing to spend money on non-essential goods signals economic uncertainty.

In general, lower-income consumers are feeling the squeeze the most. “This segment of the consumer group’s excess money has been used up and now they have a more difficult time meeting interest payments,” Morningstar analysts wrote. They add that credit card delinquencies and charge-offs for low-income consumers are returning to their pre-pandemic levels faster than those for general consumers. “The extra money of the lower income folks is running out,” Dimon said.

Consumers Still Search for Higher Yields

One continuing major trend emerged when the Federal Reserve began raising rates: deposit migration, or cash sorting. Consumers are still pulling their cash out of standard checking and savings accounts, which pay very little interest, and moving it into financial products that pay more interest, like certificates of deposit or high-yield savings accounts. JPMorgan CFO Jeremy Barnum called the shift “the dominant trend.”

This momentum was most dramatic in the early days of the rate-hiking cycle, though the trend has moderated now that rates are likely at their peak. “You still have some people moving into higher-yielding alternatives, [but] the pace of that migration has slowed, at least for now,” said Wells Fargo CFO Michael Santomassimo.

“I think that’s indicating that the covid burn-down is beginning to run its course,” Brendan Coughlin, head of consumer banking at Citizens Financial Group, added in an earnings call Wednesday. But with interest rate cuts likely delayed until later this year or further out, it’s a good bet the trend will continue.

“We don’t think it makes sense to assume that in a world where checking and savings is paying effectively zero and the policy rate is above 5% that you’re not going to see ongoing migration,” Barnum said. “Even if the current yield curve environment were to change and meaningful cuts were reintroduced … we would still expect to see ongoing migration and yield-seeking behavior.”

Banks are now pressured to pay depositors higher rates, putting a dent in their net interest income—a key performance metric describing the difference between the amount they earn on loans and what they pay on deposits. When deposit costs are higher, banks earn less.

Risks of a Strong Consumer

Banks aren’t the only ones pointing to consumer strength in the months ahead. “On balance, firms expected consumer spending to increase moderately in the near term,” a report from the Federal Reserve Bank of Cleveland concluded in the central bank’s most recent Beige Book.

Retail sales in March ran hotter than economists expected, rising 0.7% on a monthly basis compared with FactSet’s consensus estimate of 0.4%. February’s print was revised up to 0.9%. It’s a sign that consumers are still spending and the economy can continue growing.

But that growth comes with a downside risk. “This morning’s consumption data continue to tell us not to underestimate this consumer,” Wells Fargo economists wrote Monday. “That’s good for growth, but could be a problem for the Fed trying to cool inflation ... This is not the sort of spending associated with falling prices.”

Investors will be watching consumer behavior closely for signs the economy is overheating. That could be bad news for a Fed that seems even less likely to cut rates this year than it did just a few weeks ago.