Constant monitoring of the Federal Reserve's actions and discourse on whether the U.S. will enter a recession is causing us to seek evidence of systemic risk in consumer markets when it isn't there — the risk is concentrated and consumer markets are healthy.
The state of the market is being assessed incorrectly, and there are two reasons for this. First, when we imagine a "recession" we immediately think of the greatest financial crash of recent times (2008), and consequently look for signs of market collapse. Second, to support our unfounded perception of systemic risk and consumer weakness, many rely on easily misconstrued short-term data.
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This generalization is inaccurate. The personal savings rate on its own is flawed, as it simply demonstrates gross personal income versus consumption at a national level, and is a better reflection of inflation and real GDP than actual consumer savings, which are built over years. The measure also ignores consumers' ability to fund savings out of asset appreciation.
Rising credit card balances are causing a gross overstatement of worry. This growth is simply a correction from the last two years' low debt levels. Total credit card debt is still below 2019 levels and well below pre-global financial crisis levels, when adjusted for inflation and household growth. Beyond this, much of the credit card debt increase is due to a growth in new accounts rather than more debt. This is likely a result of consumers opening credit lines in new households formed in the pandemic, and fewer accounts being closed due to nonperformance, both indicators of a healthy consumer balance sheet.
Finally, the key missing piece to both metrics is they fail to capture the full picture of consumers' balance sheets. For a far more comprehensive dataset, we should turn to measures like the Federal Reserve's Distributional Financial Accounts (DFA) as it looks at assets, liability and wealth over a longer period of time, a crucial aspect in determining consumer health. The data demonstrates that most consumers can fund lifestyles through savings and asset appreciation, and points to a quarterly buildup of debt which is far less alarming.
The DFA reveals a number of notable findings. It shows that Americans' net worth is growing — and most importantly, the growth is overwhelmingly occurring among lower income consumers. From the first quarter of 2021 through the third quarter of 2022, the change in Americans' net worth was positive across all income percentiles, with growth strongest among lower income households — most notably the 20-40% and 0-20% percentiles of income households. During this same period, assets also rose more rapidly than overall borrowing. In addition, the data shows that over the past six quarters, consumer debt for the three lowest income cohorts (40-60%, 20-40% and 0-20%) has risen slower than in 2018-2019, which was a time of far lower inflation and less worry about consumer balance sheets. These conclusions hold true even when looking solely at 2022 performance.
Using accurate data, such as the DFA, dispels expectations of systemic risk but it does show pockets of manageable concentrated risk. The consumer unsecured market saw weaker credit performance over the past year, with impairments rising at a fast rate. However, much of the underperformance, until recently, has been concentrated in and a byproduct of a normal late-stage credit environment, and has been concentrated in weaker attributes (e.g., low-FICO, low-grade) which is not uncommon during a normal credit cycle.
Lenders had started tightening as early as the fourth quarter in anticipation of a possible recession. Now, the banking crisis is driving community and regional banks in particular to hit the brakes harder, stoking renewed recessions fears.
While delinquencies in the auto market are rising, this is not worrying as they are mostly normalizing toward pre-pandemic levels, despite a multiyear surge in new and used car prices. Although consumers may take on more auto-related debt, the market is cyclical, and movement here has not historically impacted the wider consumer sector.
Despite these pockets of risk, signs indicate that consumer markets are healthy. First, the fixed-rate nature of current debt can actually be considered an asset in today's environment. The majority of consumer debt is mortgages, of which more than 81% is fixed at rates of 4% or less. As rates increase, these mortgages represent a debt which is manageable and even preferable for consumers.
Second, lending sectors can rapidly respond to credit cycle changes. The subprime auto and consumer unsecured sectors made substantial underwriting amendments in 2015-2016 in response to the sectors' rapid growth and credit concerns. This led to years of subsequent good performance. Standards similarly tightened in 2022.
Third, U.S. households continue to carry much less debt relative to income than consumers in most other developed economies, and unlike those economies, the picture has materially improved in recent years, particularly for lower income consumers.
Generalizations and improper reading of data have caused disproportionate concern about U.S. consumer markets' strength. Instead, it is clear that there are a few areas of concentrated risk which do not indicate a wider systemic problem. Careful and considered readings of reliable data show that U.S. consumers are just fine.
