Thoughts

August 11, 2023 | 13:42

U.S. Household Finances in Good Shape, But...

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)

In aggregate, the finances of American households appear relatively sound, providing support to an economy that refuses to go down. However, slowing credit growth and modestly rising default rates suggest the Fed’s tightening is having the intended effect of gradually cooling demand.

Although household debt reached new highs above $17 trillion in Q2, it rose only slightly after slowing sharply early this year. According to the New York Fed’s latest quarterly report, the slowing in debt balances marks a major downshift after spiking 8.5% last year and 7.0% in 2021, the two largest annual increases since before the Great Recession. Residential mortgage balances even dipped for the first time in several years. Monthly data from the Federal Reserve show that consumer credit growth moderated to 5.8% y/y in June after peaking above 10% in April 2022. Auto loans decelerated to a 6.1% yearly rate last quarter after revving 11.2% in 2021, when rebate cheques were flying out the door. High interest rates are sapping the American household’s appetite to borrow.

So far, most households are having little trouble managing their debt in the face of rising credit costs. This reflects three things. First, most people have a job. Second, debt is low relative to rising income. The debt ratio of 86% of disposable income in Q2 is miles below the peak of 116% reached in 2008, and is still lower than a decade ago despite a prolonged period of low interest rates. Third, the debt service burden remains low. Debt payments consumed just 9.6% of disposable income in Q1, slightly below the pre-pandemic level and well below the long-run norm of 11%, according to the Federal Reserve. Just 3.9% of income was spent on residential mortgage payments in the quarter, compared with a long-run norm of 5.6%. This is because many owners latched onto rock-bottom rates in recent years, shielding themselves from the current 30-year fixed rate of over 7%. The effective mortgage interest rate paid by owners was just 3.5% in Q1 (and only slightly higher at 3.6% in Q2), little changed from the record low of 3.3% in early 2022 and well below the quarter-century median of 4.5%.

Still, rising borrowing costs are starting to pressure household finances. Servicing costs on consumer loans in Q1 are back to long-run norms of 5.7%, and have likely risen further given an additional 50-bp increase in the fed funds rate.The 90-day-plus delinquency rate on all household loans rose for a second straight quarter to 1.47% in Q2, according to the New York Fed. Moreover, while the 30-day-plus rate for new delinquencies of 3.18% is still below pre-pandemic levels, it's been rising for more than a year, led by stress in auto loans and credit cards. Low income households are likely shouldering most of the pain. The Fed’s Distributional Financial Accounts show that the lowest-income quintile was the only one to see an outright decline in consumer loan balances in the past year to Q1.

Bottom Line: Slowing credit growth and some fraying in household finances suggest the Fed may want to think twice about the risk of overtightening policy.