The Big Idea
The sun still shines on most households
Stephen Stanley | September 20, 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. This material does not constitute research.
While loan delinquencies point to a little stress at the bottom end of the income scale, the Fed’s latest Financial Accounts of the United States continues to paint a very bright picture for most household balance sheets. Real consumer spending will likely slow later this year, driven in large part by slower income growth. But any weakness for the consumer will not be driven by overextended balance sheets.
Debt loads are light
The Federal Reserve released its latest quarterly Financial Accounts of the United States report on September 12, covering the second quarter of 2024. A good place to dive into the numbers is the overall level of household debt. As a percentage of GDP, household debt fell in the second quarter for the twelfth 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
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, but this ratio also slid again in the second quarter to its lowest level in over 20 years, aside from some distorted readings during the pandemic.
Exhibit 2: Household debt-to-disposable-income ratio
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. 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 the debt service burden remains slightly below 2019 levels—9.8% in the second quarter compared to 9.9% to 10.0% in 2019. In fact, aside from the pandemic period, the measure is at its lowest level on record (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
Household assets
For a third straight quarter, the Fed’s Financial Accounts tell a very happy story for households in the first quarter. The value of household assets surged by $4 trillion in the fourth quarter of last year, almost $6 trillion in the first quarter of this year and close to $3 trillion more in the second quarter. In the latest quarter, the majority of the boost came from an appreciation in real estate holdings, while equity valuations increased noticeably.
Over the past three quarters, total household net worth jumped by more than $12 trillion to an all-time high of $163.8 trillion. Barring a swoon in the final days of the current quarter, household asset values are likely to ascend further in the third quarter, as the stock market is once again up noticeably.
Tying household balance sheets back to consumer spending, there is an important point to be made. The Fed’s tight monetary policy has made it difficult for households to liquify their soaring asset values, as high interest rates and relatively tight lending standards have made it difficult for households to tap what for many is their largest asset: their homes. In the 2000s, at the drop of a hat, homeowners could execute a cash-out refinancing when their home values shot up. With mortgage rates so much higher than before and during the pandemic, this is not a desirable option for most mortgage holders.
One indication of this dynamic is a measure that the Fed reports on in the Financial Accounts each quarter: owners’ equity as a percentage of real estate values. In the second quarter, this measure rose to 72.7%, the highest reading since 1958 (Exhibit 4). During the 2000s, even as home prices were soaring, homeowners were tapping their equity so fast that their ownership stake was actually falling. In contrast, the gauge has jumped by nearly 8% since the end of 2019.
Exhibit 4: Owners’ equity as a percentage of real estate values
The broader point is that while balance sheets are historically strong, the marginal impact of rising net worth on consumer spending, what economists call the “wealth effect,” has likely been far more limited than it might have been under a different interest rate profile.
Household liquid assets
Given the windfall that households received during the pandemic, I have closely tracked in recent years the evolution of household 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 5).
Exhibit 5: Household liquid assets
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, has risen by more than 18% from the end of 2019.
Measuring real household liquid assets, using the PCE deflator as the price index, shows that the series was mostly back to the trend line by the middle of last year (Exhibit 6). Those at the top of the income scale are still carrying an elevated level of real liquid assets relative to 2019, but this is more likely an investment decision than a predictor of future consumption, as high short-term interest rates have, for the time being, made cash an attractive investment option for the first time since before the financial crisis.
Exhibit 6: Real household liquid assets
After bottoming out last summer, real liquid assets resumed modest growth in the fourth quarter of 2023 and first quarter of this year for the first time since peaking in 2021 but fell back in the second quarter and is now little changed from a year ago. I take this as evidence that by mid-2023, 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.
If households in the aggregate no longer have an extraordinary liquidity cushion to supplement their spending, then the outlook for consumer spending reverts, as usual, to being driven mostly by the growth in income, particularly from wages and salaries.
This is the crux of my view that real consumer spending is poised to slow over the balance of the year. The ongoing moderation in the labor market is producing slower income gains, which should dampen consumer demand. Last year, real disposable income—income after inflation and taxes—jumped by 3.8% (December to December), supporting a 3.3% advance in real consumer spending over the same period.
In contrast, over the first seven months of 2024, real disposable income has risen at an anemic 1.1% annualized pace. However, real consumer spending over that same period has advanced at a 2.4% annualized pace. The result has been a steep drop in the savings rate so far this year to below 3%. In other words, consumers have been spending beyond their means recently, and I do not believe that will continue for much longer. With the labor market continuing to cool, which points to more tepid real income growth ahead, I anticipate that real consumer expenditure gains may moderate to as low as 1% late this year and early next year.
Fraying at the edges
While the aggregate balance sheet 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 little reason for alarm. Bloomberg compiles 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 7 and 8). These data demonstrate that credit card delinquencies have normalized after reaching historically low levels during the pandemic but are still running 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. Moreover, at the margin, both delinquency rates receded since early this year.
Exhibit 7: 30+-day credit card delinquencies
Exhibit 8: 90+-day credit card delinquencies
The New York Fed and Equifax compile 90+-day delinquencies for auto loans (Exhibit 9). Here, the story is more troubling, as the delinquency rate has moved well above 2018-2019 levels. In addition, unlike credit card delinquencies, which have fallen back since the start of the year, this measure has continued to ascend.
In my view, 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 broad acute stress for household finances. Still, for auto lenders and investors in that debt, this is a situation that warrants close scrutiny.
Exhibit 9: 90+-day auto loan delinquencies
Conclusion
The state of household finances is not perfect, but the latest aggregate data from the Fed confirm that, overall, the situation remains quite positive. Healthy balance sheets should help to limit the financial stress for households as the labor market. Nevertheless, I look for tepid consumer spending growth over the next few quarters, driven by pedestrian gains in real income.