Like There’s No Tomorrow: Unpacking Consumer Credit

The economic story of the year so far is how hopes for lower interest rates have been dashed by a disruption in the trend decline in inflation. The gravity-defying power of consumer spending deserves a hearty share of the blame. Unbroken by the highest cost for consumer credit in decades, it is difficult to look at spending today and find indications of a consumer that is chastened by higher financing costs.

But with pandemic-era savings now fully depleted, bridging the gap between aspirational spending and comparatively modest real income growth, consumers are running out of options. This report unpacks the latest data on consumer credit with a skeptical eye on the ability for consumers to keep borrowing. (…)

In looking at revolving credit, the category that is primarily comprised of credit card debt, we find the take-up rate of borrowers in this cycle is stunning. Take for example the fact that from the peak prior to the financial crisis in 2008 until the peak prior to the pandemic in 2020, revolving credit rose $80 billion. Contrast that with the roughly $240 billion increase from the pre-pandemic peak through March 2024. Credit card debt has grown three times as fast over just the past four years as it did during the almost 12-year stretch in the prior credit cycle.

  

Source: Federal Reserve Board and Wells Fargo Economics

Access to credit for consumers is less readily available today than it was just a year or so ago. After loosening standards in 2021 and 2022, banks have been tightening lending standards on credit cards more recently. Meanwhile, banks’ willingness to lend is lower now than it was at the height of the recessions of the early 1990s or early 2000s. Only the financial crisis and the pandemic were worse.

It is not only tough to find credit, but the cost of credit for consumers has not been higher at any point in the past 30 years. From the mid-1990s until the start of the current Fed tightening cycle, credit card interest rates never climbed above 17%. Today the APR for all borrowers is north of 21%.

Taken together, the run-up in revolving debt combined with the much higher financing costs raise doubts about the ability of credit to continue to make up for the shortfall between modest real income growth and aspirational spending. Is there a way to feel better about the consumer credit situation?

The consumer credit situation is less dire when considered in the context of high inflation experienced over the past few years. Revolving credit data are reported nominally, and since it is impossible to attribute revolving balances to specific periods of purchase, we are unable to accurately adjust the data for price changes. But inflation is certainly a factor in higher revolving balances. Consider that while revolving credit sits about 22% above its pre-pandemic February 2020 peak, the PCE deflator is up about 17%. A better way to contextualize debt burdens, however, is in the context of income.

The fact that the labor market is as tight as it has been in recent years has allowed income to grow very quickly and outpace inflation on trend. At 6.5% through March, the ratio of revolving credit as a share of disposable personal income is undoubtedly on the rise and up markedly from what was a 30-year low earlier in this cycle. Still, thanks to robust income growth, this metric is lower today than at any point in the 25-year stretch that preceded the pandemic.

  

Federal Reserve Board, U.S. Department of Commerce and Wells Fargo Economics

So by this measure that factors in strong income growth, revolving credit does not look quite as scary as it does on a level basis. But what about elevated interest rates? Even if the pile of debt looks manageable relative to income, at what point do interest rates make the cost of carrying this debt unsustainable? This is an important consideration to policymakers on the FOMC who are well aware of the lagged effects of monetary policy. Turns out we may be closer to the breaking point than the robust consumer spending in the first quarter might otherwise suggest.

(…) The key distinction is that the 2.6% share that interest payments eat up today represents the biggest share of income since the height of the financial crisis in 2008. (…)

So are there any indications that households are struggling with debt today? The share of debt that is delinquent is the best way to gauge household stress. The delinquency rate on all household debt stands at just 1.7% as of the fourth quarter, which is below pre-pandemic levels and just a stone’s throw away from the all-time low of 1.4% hit in late 2022.

Delinquency rates remain near the low end of the range for the past decade for mortgages and student loans. Yet if we look at delinquency rates for auto loans and credit cards we find that both measures are as high as they have been since 2011 when they were coming down from financial crisis era highs.

The increased transition into delinquency on credit card and autos loans is clearly not a favorable development and suggests continued reliance on credit cards will grow more challenging. But when we think of it from the broad macro perspective, the notable offset from mortgages cannot be ignored as it offers a bit more cushion for delinquencies to rise elsewhere without a credit crunch in the broad household sector.

New York Fed Consumer Credit Panel, Equifax and Wells Fargo Economics

Consumers keep spending, and they’re pulling out all the stops to do so. Credit reliance has been a key factor in helping support the consumer this cycle, but with the smallest increase in revolving credit since April 2021 in March, this source of purchasing power may be fading. Interest rates are perched at 30-year highs leading to serviceability challenges as delinquencies are ticking higher. While we’re not yet worried of a full-blown credit crunch in the household sector, the recent run-up in credit card borrowing doesn’t look sustainable. It’s no wonder households are growing a bit more choosy in spending behavior.

From BofA Institute: Continued spending momentum amid the noise

Bank of America aggregated credit and debit card spending per household rose 1.0% year-over-year (YoY) in April, following a 0.3% YoY rise in March. Monthly spending this year has been impacted by the leap year in February as well as Easter being earlier than in 2023, making for a lot of gyrations in the data.

On a seasonally adjusted (SA) basis, total card spending per household in April rose a strong 1.3% month-over-month (MoM), following a 0.7% MoM decline in March. Taking these months together, consumer spending momentum continues to appear relatively soft but stable.

Is there evidence of a recent slowdown in lower-income household (<$50K) spending? Not in our data. As Exhibit 2 shows, this group’s spending growth continued to outstrip that of higher-income households in April. And when we look at daily spending data per household on a seven-day moving average, we find that lower-income spending growth across most categories outpaced that of higher-income (<$125K) groups in late March and April.

Both cohorts experienced peaks around Easter, but the relative drop since then in spending on groceries, retail and food services was stronger for higher-income consumers. However, clothing spending growth has been softer for the lower-income cohort. (…)

Exhibit 5 also shows that, according to Bank of America internal data, lower-income household after-tax wages and salary growth has strengthened of late, growing 4.0% YoY in April. But the April Bureau of Labor Statistics (BLS) report showed that strong job gains have been cooling, which warrants close attention to see if this slowdown broadens and deepens.

According to IRS data, 2024 average tax refunds were up nearly 3.5% YoY through April 19th compared with an 8.6% decrease YoY for the same period in 2023.

Using Bank of America internal data, and using an approach of reviewing the periods of three weeks prior to and after the receipt of a tax refund as a proxy for how refunds were spent, [we found] that clothing and durable goods seemed to benefit, with the average weekly spending up approximately 35% for the three-week period after receipt of tax refunds compared with the three weeks before.

We also found aggregate consumer spending on experiences (e.g. leisure travel, in-person entertainment, restaurants) was boosted but by less than for goods. It is possible that more consumers were waiting longer for tax refunds this year before spending on bigger-ticket items like durable goods or leisure travel.

But Bank of America data also shows evidence that customers earning <$50K annually used their refunds to repay debt (regardless with whom their debts were with). Lower-income cohorts saw the largest rise in aggregate debt payments for the three-week period post tax refund compared with the three weeks before. [Data] shows that the increases in debt payments by these customers were largest for credit cards, likely due, in part, to rising interest rates.

Additionally, [data] shows that some households, especially those with lower incomes, likely saved a portion of their tax refunds resulting in a seasonal increase in median deposit balances.

• The JPMorgan Chase Institute, which studies the bank’s anonymized account data, wrote in an April note that the most recent trends suggested that “many consumers have depleted their excess savings and are returning to more routine saving behavior.” (WSJ)

China’s trade returns to growth on back of AI equipment imports

China’s Exports Return to Growth in April, Boosting Economy Overseas sales reverse March slump and expand 1.5% vs 2023

Exports increased 1.5% in dollar terms from a year earlier, reversing a drop in March, while imports climbed 8.4%, the customs administration said Thursday. That left a trade surplus of $72.4 billion for the month. Economists had forecast that exports would rise by 1.3% while imports would climb by 4.7%. (…)

Other Asian trading nations also saw overseas sales climb last month on strong US demand. South Korean exports rose almost 14%, while Taiwan reported a record level of shipments to the US.

China’s exports were slower to some of the developed economies, where complaints about cheap imports are growing. Sales to the US were little changed, while those to the European Union fell. By contrast, shipments to the Asean bloc of southeast Asian nations were up almost 13%.

The volume of exports of steel products rose 27% in the year through April, while prices continued to fall, with the value of those shipments down 13%. Countries from Europe to emerging economies like Brazil and Turkey have started probes into claims of Chinese dumping of the metal.

The unexpected jump in China’s imports was spread across many trade partners, with shipments from the US, South Korea, Taiwan, the Netherlands and Russia all rising more than 10%.

The jump in imports was largely driven by products such as chips and PC parts, “which reflect better global tech trade momentum,” said Michelle Lam, an economist at Societe Generale. It’s “more likely to be attributable to export than domestic demand.”

Country Garden Misses Bond Payment, Says Guarantor Would Step In

Chinese developer Country Garden Holdings Co. said it cannot meet initial deadlines for interest payments on two local bonds and that a state guarantor would step in — marking the first test of a key government program to shore up builder debt.

The company’s onshore unit cannot make the coupon payments on its 3.95% note and its 3.8% bond by an initial deadline of May 9, according to filings. Both securities are guaranteed by China Bond Insurance Co., a state-owned firm at the heart of a program introduced by authorities in 2022 to help private-sector developers avoid liquidity crunches. (…)

The development raises broader questions of whether other distressed developers struggling amid China’s unprecedented property crisis will also go on to miss payments, forcing the guarantor to wade in more ahead. So far at least 33 bonds have been issued under the program, with 33.7 billion yuan raised in total, according to data compiled by Bloomberg. No others have missed payments yet. (…)

The builder is fighting a liquidation petition filed by a creditor in a Hong Kong court, and the first hearing is scheduled for May 17.

Country Garden has been hit hard by the broader property crisis and now is saddled with 1.36 trillion yuan of total liabilities, according to its unaudited 2023 interim results. (…)

Contracted sales slid 83% in April after similar tumbles in the previous two months. (…)

Profits Are Booming—and That’s Shielding the Economy CEOs are upbeat, and results are on the upswing. The somewhat slower job growth reported last week isn’t the same as a major downturn.

(…) The bulk of U.S. companies have now reported first-quarter results, and they show profit growth is picking up. Earnings per share for companies in the S&P 500 now look to be up 5.2% from a year earlier, according to FactSet, better than the 3.4% analysts expected at the end of March, and marking the strongest growth in nearly two years.

Company results coming in ahead of the estimates is a regular occurrence. More unusually, analysts also spent last month lifting their current-quarter estimates. They now expect second-quarter earnings per share to gain 9.8%, compared with 9% at the end of March. The last time analysts spent the first month of a quarter raising rather than lowering earnings estimates was during the fourth quarter of 2021, according to FactSet earnings analyst John Butters.

Corporate profits are important because they show the U.S. economic engine continues to purr. While some other economic indicators, such as consumer-sentiment readings, have been downbeat, and inflation has ticked up, a strong U.S. profit performance typically points toward continued expansion.

The drift higher in earnings estimates might be because companies, instead of feeling a need to temper analysts’ optimism and nudge estimates lower, are upbeat themselves. Among companies in the S&P 500, the term “recession” showed up in just 100 transcripts of earnings calls, investor events and conferences recorded in the first quarter, according to FactSet. That was down from 302 in the first quarter of 2023, and the fewest in two years.

Survey-based measures of corporate sentiment have picked up. The Business Roundtable’s index of chief executive officers’ economic outlook rose to the highest level in the first quarter since the second quarter of 2022. Indexes of CEOs’ hiring and capital-spending expectations have gained ground. A survey of chief financial officers conducted by Duke University’s Fuqua School of Business with the Federal Reserve banks of Atlanta and Richmond showed a similar increase in optimism.

“There is not a reason if profits are good to retrench,” said the Duke economist John Graham, who directs the CFO survey. Moreover, many CFOs say their companies are still struggling to attract workers.

For now, Graham thinks companies are in the mode of adding workers when the profit outlook is good, and holding employment steady if the outlook becomes shaky, rather than shedding the employees they put so much effort into hiring. So even if earnings do falter, companies might be slow to turn to layoffs. (…)

Initial claims for unemployment insurance—a leading indicator of layoff activity—have remained low. (…)

True for S&P 500 companies.

Not for mid and small caps where profits and margins are not rising as Ed Yardeni illustrates:

And not for very small biz:

  

• NFIB Job openings are now back in line with levels reached before the pandemic (2017-2019).

• Job creation plans are below what would be typical in a strong growth economy.

• Labor cost reported as the single most important problem for business owners increased 1 point to 11 percent, only 2 points below the highest reading of 13 percent reached in December 2021.

Data: Goldman Sachs 10,000 Small Businesses Voices. Chart: Axios Visuals

Employment reports indicate strong labor markets, but it is less clear where all these jobs are being created. Non-professional services spending is strong, but not strong enough to explain the reported job creation. GDP growth was weak in the first quarter, so where are all those job increases occurring? Small businesses are not reporting net gains in employment. Job reports have been puzzling for some time now, and with an election at hand may remain so until after the election. (NFIB)

Yes, large companies are doing very well, but they are not the economy.

Investors are totally cognizant of these trends (charts courtesy of Ed Yardeni):

• S&P 500/S&P 600

• S&P 100/S&P 500

• S&P 500 equal-weighted/market cap-weighted

Perhaps the real shield to the economy is from the wealth effect from equities and housing.

The economy looks pretty great for Americans who own their own homes — that’s nearly 66% of the population! A record $11 trillion of home equity is “tappable,” meaning homeowners can borrow against it while maintaining at least 20% equity in the house, per the report, which looks at data from March. About 48 million folks have access to tappable equity, with an average of $206,000 per mortgage holder.

Data: ICE; Chart: Axios Visuals

• Royal Caribbean recruiting thousands to meet surging demand, sources say The company confirmed it will hire around 10,000 workers this year

As to employment, so far, so good but recall these charts from recent posts:

Cumulative pandemic-era excess savings

This is helping:

The price of a barrel of West Texas Intermediate crude is falling again today, and at least as of the time I’m typing this it’s right around $77. Just a month ago, it was above $85. (Bloomberg)

Rents Set to Be Last Domino to Fall in Global Inflation Battle

Surging rents across many developed economies are proving to be a stubborn hurdle for central banks as they struggle to nail down inflation once and for all this tightening cycle.

In the US, UK, Canada and Australia, rapidly rising housing costs — which have a hefty weighting in consumer price index baskets — are preventing inflation from declining closer to central banks’ targeted levels. The danger is that workers will demand even fatter pay checks to deal with the cost-of-living squeeze, undermining the inflation fight even further. (…)

“I am confident that as long as market rents remain low, this is going to show up in measured inflation,” Powell told reporters last week after the Fed’s two-day policy meeting. The central bank held rates at a more than two-decade high, while signaling a desire to cut when confident that inflation is under control. Traders are currently betting on at least one 25-basis-point rate cut this year.

Still, Powell may have to wait. Household expectations about the change in the cost of rent have risen sharply from last year, with rental costs expected to increase by 1.5 percentage points to 9.7% for the next year, according to a survey by the New York Fed released Monday. (…)

“Housing is a real problem in the United States due to a huge shortage of affordable housing, and in part because of high interest rates,” Treasury Secretary Janet Yellen told Bloomberg News. “That said, I strongly believe — I think it is highly likely — that shelter costs, which have been pushing up inflation, will come down.” (…)

Mrs. Yellen surely meant shelter inflation because shelter costs never come down. As a labor expert, she should know the tight relationship between wages and rents. People generally chose their abode based on what they can afford, whether they buy of they rent.

ACCURACY MEASURED

Data: UmpScorecards; Chart: Will Chase/Axios

• The Forecasting Record of the Fed and the Market (Apollo)

The Fed started publishing the dot plot in 2012, and comparing the Fed’s forecasts with the forecasts from Fed funds futures yields three important conclusions, see charts below:

1) The Fed’s and the market’s forecasts about the future path of the Fed funds rate are almost always wrong.

2) The forecasts are very similar, and the Fed has managed to anchor market expectations about where it thinks the Fed funds rate is going.

3) The direction of the forecasting mistake is always identical, suggesting that the market is taking its cue about the future path of interest rates from the Fed’s dot plot.

The good news is that the Fed is able to anchor market expectations, and thereby reduce volatility in financial markets.

The bad news is that when the Fed’s forecast is wrong and the FOMC has to move from three cuts in 2024 to say, one cut, it will hurt Fed credibility.

The US economy’s lower interest-rate sensitivity, combined with strong structural and cyclical tailwinds to growth, brings us to the conclusion that the Fed will not cut interest rates in 2024.

Source: FOMC, Bloomberg, Apollo Chief Economist