Thoughts

December 06, 2024 | 15:09

Are U.S. Low-income Earners the Next Source of Resiliency?

Economist

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

Sal Guatieri

Senior Economist and Director
Economics

Sal Guatieri is a Senior Economist and Director at BMO Capital Markets, with over two decades experience as a ma... (Read more)

One reason the U.S. economy weathered the interest-rate storm remarkably well is that many households were partly shielded by manageable debts and fixed mortgage rates. Despite a more than 5-ppt rise in the federal funds rate and 4-ppt climb in long-term mortgage rates, debt service payments consumed just one percentage point more after-tax income in the second quarter of 2024 than in early 2022. In fact, the average share (11.5%) was no higher than before the pandemic—when borrowing costs were nearly four percentage points lower. Moreover, upper-income households, in particular, benefited from rising home and equity prices. Not surprisingly, they were the ones carrying the torch through the blizzard of rate hikes.

Nonetheless, economic growth did downshift by about 1-ppt during this two-year period largely due to a moderation in consumer spending. And, that’s mostly because lower-income households were less shielded from the storm and took the brunt of higher borrowing (and living) costs. Debt payments typically consume a larger share of their income. In 2022 (the last year of available data), the lowest-income quintile spent 18% of income on debt payments, more than other groups, and one-in-four spent over 40%. They also had little to no savings to fall back on, and owned fewer interest-bearing assets, which, for higher-income groups, eased the sting of rising credit costs. Furthermore, proportionately more low-income households made payments to landlords than lenders, and thus found themselves on the wrong side of a 20% surge in residential rents in the past three years, while many upper-income earners enjoyed low and stable mortgage costs.

However, with the interest rate (and inflation) storm now abating, lower-income earners have the most to gain from an improved financial climate. As debt payments ease, their spending power will increase. Many will also benefit from President-elect Trump’s proposal to repeal income taxes on worker tips, overtime pay, and social security benefits, though it may take until 2026 to become law. Along with a likely pickup in spending by this group, current high delinquency rates on credit cards and auto loans should reverse course next year.

Retail giant Walmart singled out their well-heeled customers as the source of a recent bounce in sales. They might soon have company.