The Big Idea

A strong consumer balance sheet bodes well for spending

| March 8, 2024

This document is intended for institutional investors and is not subject to all of the independence and disclosure standards applicable to debt research reports prepared for retail investors.

The latest round of data from the Fed continues to paint a very bright picture for household balance sheets, which bodes well for near-term consumer spending. There are issues for some households toward the bottom of the income scale, based on loan delinquencies. The balance sheet snapshot came in the latest Financial Accounts of the United States on March 7.

Debt loads are light

A good place to start is the overall level of household debt.  As a percentage of GDP, household debt fell in the fourth quarter for the tenth straight quarter, reaching its lowest reading in over 20 years (Exhibit 1).  The series has fallen well below the trend line established from 1970 through 2000.

Exhibit 1: Household debt-to-GDP ratio

Source: BEA, Federal Reserve.

A similar way to assess the scale of household debt is to compare it to disposable income (Exhibit 2). This gauge is slightly less impressive than the debt-to-GDP series, as the ratio has settled in recent quarters near 2019 levels.  Still, as with the former gauge, the debt-to-disposable-income ratio is roughly at its lowest level in over 20 years, aside from some distorted readings during the pandemic.

Exhibit 2: Household debt-to-disposable income ratio

Source: BEA, Federal Reserve.

Debt service burden

In a separate report, the Federal Reserve publishes estimates of the debt service burden, defined as the percentage of disposable income needed to stay current on debt payments.  The Fed makes two sets of calculations.  The narrow one is called the debt service ratio and only covers traditional debt. The financial obligations ratio takes a broader view, including rent payments, auto lease payments, homeowners’ insurance, and property tax payments (the Fed intends to discontinue the calculation of the financial obligations ratio, so the latest data, which cover the third quarter of 2023, will be the last for this series).

With interest rates surging since early 2022, one might imagine that even for a constant level of debt, the servicing burden of that borrowing would have risen sharply.  However, the Fed data show that both measures have been roughly steady on balance over the past 18 months and are historically low.  In fact, aside from the pandemic period, both gauges are near the lowest on record going back to 1980 (Exhibit 3).  This is a testament to the prevalence of fixed-rate debt held by households, most notably for mortgages.

Exhibit 3: Debt service burden and financial obligations ratio

Source: Federal Reserve.

Household assets

The Fed’s Financial Accounts data for the fourth quarter tell a very happy story for households.  The value of household assets surged by $5.0 trillion in the quarter, as equity valuations increased noticeably, pushing household net worth up by $4.8 trillion.  Over the course of 2023, total household net worth jumped by nearly $12 trillion to an all-time high of $156.2 trillion.

Household liquid assets

Now we turn to the lynchpin of my analysis of household finances since the beginning of the pandemic, liquid assets. This series covers the portion of the balance sheet that represents cash equivalents and includes currency, bank deposits, and money market fund shares.  I have emphasized this measure is a proxy for spendable funds.

Household liquid assets spiked during the pandemic, reflecting in large part the unprecedented waves of federal government largesse.  Most economists presumed that consumers would spend down those balances quickly once the economy fully reopened.  However, liquid assets have remained elevated by historical standards (Exhibit 4).

Exhibit 4: Household liquid assets

Source: Federal Reserve.

To be fair, a significant portion of the increase in spending power represented by these liquid assets has been eroded by inflation. The level of prices, as measured by the PCE deflator, is up by roughly 17% from the end of 2019.

Exhibit 5: Real household liquid assets

Note: Real household liquid assets using PCE deflator as the price index.
Source: Federal Reserve.

Despite inflation, real liquid assets were mostly back to the trend line by last summer.  Indeed, as I laid out in a previous piece examining the Fed’s liquid assets data broken down by income quintiles (these more detailed data are published with a lag of a month or two relative to the aggregate figures), by the end of the third quarter of 2023, real liquid assets for households in the bottom four quintiles had roughly returned to the pre-pandemic levels.  Those at the top of the income scale were still carrying an elevated level of real liquid assets relative to 2019, but this was more likely an investment decision than a predictor of future consumption, as high short-term interest rates have made cash in money market funds an attractive investment option for the first time since before the financial crisis.

The aggregate new data for fourth quarter corroborate this hypothesis.  Real liquid assets resumed growth for the first time since peaking in 2021.  I take this as evidence that by the end of the third quarter, households viewed their cash positions as back to “normal” (presumably, if they were sitting on elevated liquidity that they intended to spend, the series would have continued to decline).  In any case, the real household liquid assets series inched up by about $150 billion in the fourth quarter.

In my view, this offers a bit of good news and a bit of bad news regarding the outlook for consumer spending.  The bad news is that most households no longer hold an extraordinary liquidity cushion that they intend to tap to underwrite spending going forward.  By late last year, in my view, consumer spending was, as usual, being driven mostly by the growth in income, particularly coming from wages and salaries.

The good news is that the labor market has remained robust through early 2024 and is generating more than enough income growth to support solid real consumer expenditure gains.  The fact that household liquid assets in real terms rose in the fourth quarter suggests that households in the aggregate were not in distress and were not straining to achieve the 3% annualized real increase in consumption registered in the second half of last year.

Fraying at the edges

While the aggregate figures remain robust, some households, especially those at the lower end of the income scale, have begun to struggle somewhat under the weight of the surge in prices seen over the past few years.  Analysts frequently cite rising credit card and auto loan delinquencies as evidence of financial stress.

A careful examination of the credit card payment data suggests no reason for alarm, at least based on 30+-day and 90+-day credit card delinquencies for a group of servicers including Amex, Bank of America, Capital One, Chase, Citibank, and Discover (Exhibits 6 and 7).  These data show that credit card delinquencies have normalized after reaching historically low levels during the pandemic but are still running near or somewhat lower than the 2018 and 2019 levels. I cut off the graphs at a 10-year history to keep the scale reasonable, but delinquencies were orders of magnitude higher in the years during and immediately after the financial crisis not surprisingly, since the unemployment rate was far higher back then.

Exhibit 6: 30+-day credit card delinquencies

Source: Bloomberg.

Exhibit 7: 90+-day credit card delinquencies

Source: Bloomberg.

Another angle looks at 90+-day delinquencies for auto loans, as compiled by the New York Fed and Equifax (Exhibit 8).  Here, the story is more troubling, as the delinquency rate has moved well above 2018-2019 levels. I would argue that auto loans are a bit of a special case, hit by the perfect storm of a surge in used vehicle prices in 2021 and 2022, followed by price declines since then.  In other words, the particular issues faced for auto loans may be more indicative of what has transpired in the auto sector than a sign of broader stress for household finances.  Still, for auto lenders and investors in that debt, this is a situation that warrants close scrutiny.

Exhibit 8: 90+-day auto loan delinquencies

Source: NY Fed, Equifax, Bloomberg.

A positive situation

The state of household finances is not without blemishes, but the latest aggregate data from the Fed confirm that, overall, the situation remains quite positive.  For the time being, consumer spending should remain well supported, though I do expect to see some slowing over the course of this year, as the labor market and in turn income growth moderates.

Stephen Stanley
stephen.stanley@santander.us
1 (203) 428-2556

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