The (Over) Leveraged Consumer

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We saw the news from the most recent Federal Reserve’s monthly Consumer Credit report and initially yawned.  It shows that total consumer credit continued to grow in February, but not in a surprising or newsworthy way.  A few details from the report:

  • U.S. consumer credit rose 4.5 percent at a seasonally adjusted annual rate in February to $4.04T; significant growth, but down from the January growth rate of 5.3 percent.
  • Revolving credit, which includes credit-card debt, rose 3.3 percent to $1.061T, rising at a slightly faster pace than 3.0 percent in January.
  • Non-revolving credit, which includes student and auto loans, grew at a healthy clip of 4.9 percent to $2.98T in February (albeit a lower growth rate than the 6.1 percent growth seen in January).
  • 24 month personal loan interest rates dropped to an average of 10.36 percent from 10.65 in Q4 2018

The Fed made more news earlier in the year with its successive announcements decreasing guidance on future rate hikes in 2019, from four to two and then – in a major shift in policy – from two to none. There was an immediate realignment in the bond market which has now priced in a Federal Reserve interest rate cut this year. The result was an inverted yield curve with a lower yield on the 10 year treasury than that of the 3 month treasury for most of the last week of March.  Historically an inversion in the 10-year/3-month has been an almost perfect predictor of a recession in the near future. 

What made more news this week was the jobs report touting that U.S. employers added 196,000 jobs in March, meaningfully beating Wall Street expectations.  So, this news must mean that the hype about an impending recession is greatly overstated, right?  Not so fast.

A Possible Tipping Point on the Horizon

On the surface it appears that the economy is still roaring along, with huge payroll gains in March, and the unemployment rate holding steady at 3.8 percent. Wage gains fell off the recent strong pace, increasing just 0.14% for the month and 3.2% year over year, below expectations of the 3.4% pace from last month. However, we are also starting to see some signs of discontent among consumers with the latest Conference Board Consumer Confidence Index declining in March. The Index now stands at 124.1, down from 131.4 in February. 

The University of Michigan Survey of Consumers reports sentiment rose 4.9 percent in March, but that is down 3.0 percent from one-year ago. Overall the view of current economic conditions rose 4.4 percent in March, but even that is down 6.5 percent from one-year ago. It is important to remember that the unemployment rate is a lagging indicator, and some of the data above suggests that consumers don’t all believe the good times are going to keep rolling in the future. Another data point that gives us pause is the Challenger layoff report for the first quarter of 2019 – it showed job layoffs rising 35% from the first quarter of 2018, in what was the worst first quarter report since 2009.

As consumer debt continues to grow and remain at historic levels, we are also seeing a gradual ramp up of credit card interest rates. According to the Federal Reserve’s monthly Consumer Credit report, credit card interest rates spiked to 16.91 percent in February, compared with 14.44 percent in 2017.  To put that in perspective for the 44 percent of U.S. households carrying revolving credit card debt with an average revolving balance of $18,600, this change increases the amount of time to pay off the credit card by 2 years and 4 months (from 20 years and 2 months to 22 years and 6 months). In addition, a recent analysis showed that Americans are on track to pay $122 Billion in credit card interest this year, which is 50 percent more than five years ago.

As interest rates rise, and credit balances continue to grow, the risk to consumers is real. Many are in a precarious financial position. We saw this recently with the government shutdown, where impacted workers were forced to drain savings accounts, delay mortgage payments and carry higher balances on their credit cards. Over a third of Americans report putting everyday expenses like groceries and gas on credit cards. A majority of Americans can’t handle a $500 unexpected expense.

The shift in policy from the Federal Reserve in March may mitigate some short term consumer credit issues, but with continued consumer credit usage habits, rising debt levels, lack of real wage growth, and increased APRs, we seem to be just kicking the can down the road. 

Andrew Housser co-founded Freedom Financial Network in 2002 and Bills.com in 2005. Andrew sits on the board of directors of several startup companies as well as two independent school boards.