Everyone is stressing about consumer debt. Investors have been dropping the shares of big banks, credit-card specialists and younger fintechs because of fears about the pain that rising living costs and interest rates will inflict on borrowers. The weird thing is that households in the US, UK and much of Europe are in pretty good shape and showing few signs of financial strain.
The reasons to worry are obvious. JPMorgan Chase & Co. is cutting hundreds of US home-loan staff because of a collapse in demand for mortgages as prime borrowing rates rush towards 6%. At the other end of the scale, valuations have tumbled among Buy Now Pay Later lenders such as Block Inc. (formerly Square) or privately held Klarna Bank AB, as investors fret about slower spending and rising risks. Even shareholders of Goldman Sachs Group Inc. reacted badly to a Bloomberg News report last week that Marcus, its online bank, would suffer another $1.2 billion loss this year — although that is due to its heavy investment in building the business, rather than its loans turning sour.
The world feels fragile, especially if you spend a lot of time looking at financial markets, and consumer sentiment has plummeted. But underpinning households — and potentially Western economies broadly — is the huge amount of savings and debt reduction during the Covid crisis. People started this year with spare cash equivalent to more than 13% of 2019’s gross domestic product in the UK, about 11.5% of GDP in the US and between 5.5% and 7.5% in Germany, France and Italy.
Household balance sheets are much stronger than before the pandemic. In the US, there are far fewer subprime car loans and credit-card borrowers than in the past, according to Matthew Mish, credit strategist at UBS Group AG. The trend toward financial health might have been accelerated by the lifestyle curbs and income support during Covid lockdowns, but the improvements had been underway since 2013.
In recent months, the share of borrowers missing debt repayments has been growing, but it is still at or below 2019 levels. “I don’t expect we will see a level of deterioration that is concerning in the next few months, although perhaps we will in the next few quarters,” Mish says. “I’m concerned more with consumers’ willingness to spend than their ability to spend.”
Spending remains solid for now. US personal consumption expenditures did slip in May for the first time this year, but only slightly. There is no collapse in demand and spending on services continued to grow even if goods purchases were down. Along with high savings and low debt, consumers are supported by very high rates of employment and labor shortages that are helping to drive wage growth. In the US, even high gas prices aren’t as bad as they seem.
Still, inflation is outpacing wage growth for many, and economists fear that people will burn through their spare cash to cope. One of the only past eras that might be a guide to what happens next is the spell after World War II. Back then, people in the US and UK entered peacetime with high savings and pent-up demand that also buoyed inflation for years. But when Dario Perkins, a macro strategist at independent research firm TS Lombard, looked into this period, he found that consumers didn’t splurge and, apart from brief spell in the UK, didn’t in aggregate spend more than they earned. A cushion of savings was protected.
Today, the spare cash is mostly in the hands of the wealthy, who are least likely to spend it anyway. But those with lower incomes are still financially stronger than they have been for some time. There are some signs in the US that people are adding debt to support lifestyles. Growth in revolving credit as a share of consumer spending has leapt towards levels not seen since 2007, according to data from the Federal Reserve Bank of St. Louis. Growth in consumer credit hit an annualized rate of nearly 13% in March, its fastest in more than two decades.
Indebtedness is still relatively low, however: Total US consumer credit as a share of GDP is down to about 18.5%, the same level as late 2015. Even among US borrowers without university education, which UBS Evidence Lab uses as a proxy for lower-income groups, unsecured debt is barely one-fifth of annual income and has been declining since 2015.
If anything, banks and credit-card companies are itching for consumers to borrow more. Most have been telling investors for months that interest-earning card balances should soon rise once more, but customers have maintained stubbornly high monthly repayments. Life is undoubtedly getting tougher and costlier for some, but bank investors look to have overreacted so far. Watching employment rates will be key: If people start to lose work and wage growth flags too, that’s when the bad debts will mushroom.
Bloomberg News provided this article. For more articles like this please visit
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