Have US consumers finally read the recession script?
The key message
Quarterly US consumer credit flows (Source: FRED; CMMP)
The key message
Have US consumers finally read the recession script?
Quarterly US consumer credit flows slowed to only $4bn in 3Q23, down from $26bn in 2Q23 and $52bn in 1Q23 (see key chart above). These latest quarterly flows are the weakest since 2Q20, and represent only a very small fraction of the pre-pandemic average quarterly flow of $45bn.
Monthly US consumer credit flows (Source: FRED; CMMP)
Monthly flows were volatile during the 3Q23 (see chart above). The flow of consumer credit recovered in September to £9bn after repayment of $16bn in August, but remained below July’s flow of $11bn. Three-month moving average flows fell steadily, however, from $7.8bn in July to $2.8bn in August and $1.8bn in September. These smoothed flows compare with the pre-pandemic average of $14.8bn.
So what?
In recent quarters, we noted the sharp moderation in US consumer credit demand. Weakness in the 3Q23 and revised figures for 2Q23 (revised lower) indicate much weaker dynamics and elevated risks to US consumption and the growth outlook.
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
50 years of US public sector debt dynamics – plotted differently! (Source: FED;CMMP)
The key message
If you wanted to create panic over US public sector debt there are a number of tactics that you could use:
ignore the fact that US debt is a liability for one economic sector and an asset for another;
make no comparison with GDP;
ignore inflation etc.
Alternatively, you could simply present your data using linear scales – an easier and almost guaranteed method to instil panic!
1 unit of XZY growing at 10% p.a. over 100 years plotted on a linear scale (Source: CMMP)
Why is this a smart tactic for creating panic?
In the case of any long time series data that has low initial values and a constant growth, the use of a linear scale will always create a chart that is flat for a long period at the start, then becomes steeper and steeper before becoming virtually vertical (see chart above). Readers’ eyes will naturally focus on the steepening of the graph, thereby leading to the conclusion that some form of critical limit has been reached
BINGO – “PANIC ALERT!”
In contrast, the wrong tactic for creating panic would be to present data using a log scale (the maroon line in the key chart). Rather than illustrating the absolute level of US debt (the blue area) this would show its rate of change.
As can be seen, this is (1) fairly constant over time (US debt roughly doubles every ten years in nominal terms) and (2) is slower now than in early parts of the period shown. Presented this way (see chart below), the same underlying data is much less likely to create panic…
1 unit of XZY growing at 10% p.a. over 100 years plotted on a log scale (Source: CMMP)
For the rest of us, it is worth considering how different parties chose to present the same data to support their respective arguments, especially as concerns (false or otherwise) over the US debt ceiling intensify.
Remember, a chart of US public debt using a linear scale is highly likely to create panic, even if the rate of change of debt is constant.
Trends in monthly US consumer credit flows ($bn) (Source: FED; CMMP)
The key message
The relative resilience of US consumers in relation to their UK and euro area (EA) peers has been an important theme in the post-pandemic “messages from the money sector.”
Monthly US consumer credit flows in December 2022 and January 2023 suggest, however, that demand for consumer credit is moderating sharply.
While it is too early to conclude that the US consumer is cracking, it seems reasonable to expect further moderations in the demand for consumer credit, pressure on US consumption, and more convergence in the messages from the US, UK and EA money sectors in 2023.
Is the US consumer starting to crack?
The US has experienced 29 consecutive months of positive monthly consumer credit flows since August 2020. The latest FED data release for January 2023 (published yesterday, 7 March 2008) showed a monthly flow of $14.8bn, up from $10.7bn in December 2022, but well below the $36.1bn flow recorded in November 2022, however.
The key point here is that the last two months’ flows were below the average pre-pandemic flow of $14.9bm (see key chart above). The 3m MVA of monthly flows ($20.5bn) is still above the pre-pandemic average, so too early to argue that the US consumer is cracking. At least not yet…
Recall that consumer credit is the second largest financial liability for US households (24% total) after mortgages (64% total) and that it displays a relatively stable relationship with disposable personal income. A moderation in demand for consumer credit is entirely consistent with the fact that the consumer credit/disposable personal income ratio is close to the upper end of its historic range at a time of rising rates. Hence, it is also reasonable to expect demand for consumer credit to moderate further, putting pressure on consumption in the process.
Monthly consumer credit flows as a multiple of pre-pandemic averages (Source: FED; BoE; ECB; CMMP)
Recall also that in the face of pressures on real household disposable income, consumers have the option to borrow more, save less and/or consume less. In terms of borrowing more, monthly flows of consumer credit since January 2021 have highlighted the relative resilience of US consumers in relation to their UK and EA peers.
From an asset allocation perspective, it is important to see if the last two months’ trends continue to determine whether this relative resilience is sustainable or whether the messages from the three money sectors will converge further. More to follow in 1Q23…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Assessing the state of the US consumer balance sheet
The key chart
Trends in the stock of US consumer credit ($tr) and the consumer credit to DPI ratio (%) (Source: FED; CMMP)
The key message
What are the implications of buoyant US consumer credit flows for the state of household balance sheets?
Consumer credit is the second largest financial liability for US households (24% total) after mortgages (64% total). This structure has changed little over the past 20 years, although the relative importance of mortgages (up then down) and consumer credit (down then up) fluctuated in the interim period.
Consumer credit displays a relatively stable relationship with disposable personal income (DPI). The recent moderation in monthly credit flows is consistent with the consumer credit to DPI ratio being at high end of its narrow, historic range (at the end of 3Q22).
Mortgage debt, in contrast, displays a more volatile relationship with DPI. Importantly, the deleveraging of the US HH sector in the post-GFC period is due almost exclusively to a reduction in excess mortgage indebtedness. Consumer credit indebtedness is largely unchanged.
Two key messages here:
It is reasonable to assume that the demand for consumer credit will continue to moderate, putting pressure on consumption in the process
Overall HH sector risks associated with the level of indebtedness and affordability of debt remain more manageable than in the pre-GFC period
Recall that the US led advanced economies in the structural shift away from relatively high-risk HH debt towards relatively low-risk public debt in the post-GFC period.
More elevated HH debt risks can be found elsewhere…
Risky US consumer credit dynamics?
In my previous post, I noted that US consumers were doing their level best to counter the “US slowdown” narrative. While consumer credit demand has moderated from its recent highs, monthly flows in November 2022 were still almost double their pre-pandemic average flow. In response, I was asked what this means for the state of consumer balance sheets. This post provides a summary response.
How important is consumer credit?
Trends in stock of consumer credit broken down by type (Source: FED; CMMP)
Consumer credit is the second largest financial liability for US households (24% total), after mortgage debt (64% total). The structure of financial liabilities has changed little over the past 20 years, although there has been important variations in the relative importance of mortgages (up then down) and consumer credit (down then up) during the interim period (see charts above and below).
Structure of US consumer credit (% total) over past 20 years (Source: FED; CMMP)
What is the relationship with disposable personal income?
Trend in consumer credit / disposable personal income ratio (%) (Source: FED; CMMP)
Consumer credit has also displayed a relative stable relationship with disposable personal income (DPI) over this period. The recent moderation in demand is consistent with the fact that the ratio was close to the upper end of its historic range at the end of 3Q22 (see chart above).
Trends in HH credit / disposable personable income ratio by type (Source: FED; CMMP)
Mortgage demand, in contrast, has displayed a more volatile relationship with DPI over the period (see chart above). Indeed, the deleveraging of the HH sector in the post-GFC period is due almost exclusively to a reduction in mortgage indebtedness (see chart below). Consumer credit indebtedness is largely unchanged since the GFC.
Trends in HH credit / disposable personable income ratio by type (Source: FED; CMMP)
Conclusion
Two key messages here:
It is reasonable to assume that the demand for consumer credit will continue to moderate, putting pressure on consumption in the process
Overall HH sector risks associated with the level of indebtedness and affordability of debt remain more manageable than in the pre-GFC period
Recall that the US led advanced economies in the structural shift away from relatively high-risk HH debt towards relatively low-risk public debt in the post-GFC period.
More elevated HH debt risks can be found elsewhere…
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Trends in US monthly consumer credit flows (Source: FRED; CMMP)
The key message
US consumer credit demand remains strong in absolute and relative terms but the growth momentum is slowing. A key signal to watch in 4Q22 and beyond…
The US has seen 25 consecutive months of positive monthly consumer credit flows since August 2020. The latest data FED data point for September 2022 (published yesterday, 7 November 2022), showed a monthly flow of $26bn (3m MVA). This was 1.8x the average pre-COVID flow of $14.8bn. Comparable multiples for the euro area and UK were 0.6x and 1.0x average pre-COVID flows respectively, highlighting one reason for the relative strength of the US recovery.
In my previous post (before yesterday’s data release), I highlighted that US monthly flows had been more than double their pre-COVID average since March 2022 and suggested that, “the risks to the US growth outlook include the sustainability of current consumer credit demand.”
September broke this trend and while it is too early to draw definitive conclusions it is important to note the slowing growth momentum since April 2022 when monthly flows peaked at $37bn (3m MVA), 2.5x the pre-COVID average (see key chart above).
A key signal for 4Q22 and beyond…
Please note that these summary comments and the chart above are abstracts from more detailed analysis that is available separately.
Four challenges to the “over-indebted US economy” narrative
The key chart
Share of outstanding non-financial debt by sector (Source: FED, CMMP)
The key message
The latest “Financial Accounts of the United States” published by The Federal Reserve at the end of last week challenges the popular, but flawed, narrative of an “over-indebted US economy”.
This narrative typically focuses on the outstanding stock of US nonfinancial debt, which hit another new high of $67.6 trillion at the end of 2Q22. Mistakenly, however, it ignores:
The significant shift away from private to public sector debt. The structure of US debt is now the mirror image of its pre-GFC structure following the shift away from relatively high-risk household (HH) debt towards lower-risk government debt (see key chart above)
The on-going, passive deleveraging of the HH sector. The HH debt ratio has fallen from its peak of 99% GDP at the end of 1Q08 to 75% at the end of 2Q22, very slightly above its post-GFC low
The relatively low levels of business (NFC) and HH indebtedness in a global context. The US is one of only three, BIS-reporting advanced economies with both NFC and HH debt ratios below the BIS threshold limits (above which debt becomes a constraint on future growth)
Key distinctions between public and private sector debt and their implications. Government debt represents financial wealth for the private sector, hence its position on the asset side of the private sector’s balance sheet. Furthermore, governments do not face the same constraints as the private sector. As a currency issuer, the US government cannot become insolvent in its own currency since it can always make payments as they come due in its own currency.
CMMP analysis believes that it is more accurate to view public sector debt as money in circulation rather than as debt in its more widely-held sense. In this context, “the idea of having to pay back money already in circulation [another feature of the flawed narrative] makes little sense.” (Alfonso, 2020. “Does the National Debt Matter?”)
Challenging flawed narratives
Trend in outstanding stock of US non-financial debt in $ trillions (Source: FED; CMMP)
According to the latest financial accounts, the outstanding stock of US nonfinancial debt reached $67.6 trillion at the end of June 2022 (see chart above).
Federal debt of $26.3 trillion accounted for 39% of total debt, followed by NFC debt of $19.5 trillion (29% total), HH debt of $18.6 trillion (27% total) and state and local debt of $3.3 trillion (5% total). The total debt ratio fell to 272% GDP, down from 307% GDP in 2Q20 at the height of the COVID-19 pandemic.
Share of outstanding non-financial debt by sector (Source: FED, CMMP)
The structure of US debt is now the mirror image of the structure that existed before the global financial crisis (GFC). At the end of 2Q07, HH debt accounted for 43% of outstanding nonfinancial debt, followed by NFC debt 30% and public sector debt (federal, state and local) 27%. Today (at the end of 2Q22), public sector debt accounts for 44% of outstanding debt, followed by NFC debt 29% and HH debt 27%. This represents a very significant structural shift away from relatively high-risk HH debt towards lower-risk government debt in the post-GFC period (see chart above).
Trends in HH debt ($ tr) and the HH debt ratio (% GDP) (Source: FED; CMMP)
The HH debt ratio has fallen from a peak of 99% GDP at the end of 1Q08 to 75% at the end of 2Q22 (see chart above). The peak level was 14ppt above the threshold level of 85% GDP above which debt is believed to be a constraint on future growth. The current level is slightly above its post-GFC low of 74% at the end of 4Q19.
The post-GFC period has been one of passive HH deleveraging.
Trends in HH and NFC debt ratios (Source: FED; CMMP)
The US is one of only three BIS-reporting advanced economies that has both HH and NFC debt below the maximum BIS threshold limits (along with Germany and Italy). The NFC debt ratio currently stands at 78% GDP, down from a recent high of 91% GDP at the end of 2Q20. For reference, the BIS maximum threshold limits for HH and NFC debt are 85% GDP and 90% GDP respectively (see chart above).
As shown in the chart below, the US private sector debt ratio of 153% GDP is now only slightly above the 145%-150% GDP range that characterised much of the past decade up until the COVID pandemic.
Trends in private sector debt ratio (% GDP) (Source: FED; CMMP)
Important distinctions exist between private sector and public sector debt, including:
While private sector debt is debt sitting on the liability side of the private sector’s balance sheet, government debt represents financial wealth for the private sector and sits on the asset side of the private sector’s balance sheet
As currency users, HHs and NFCs face obvious constraints on their levels of debt. “Taking on too much debt can, and does, lead to bankruptcy, foreclosure, and even incarceration” (Kelton, 2020)
In contrast, as a currency issuer, the US government cannot become insolvent in its own currency since it can always make payments as they come due in its own currency
CMMP analysis believes that it is more accurate to view public sector debt as money in circulation rather than as debt in its more widely-held sense. In this context, “the idea of having to pay back money already in circulation [another feature of the flawed narrative] makes little sense” (Alfonso, 2020. “Does the National Debt Matter?”).
Please note that the summary comments and charts above are abstracts from more detailed analysis that is available separately.
Total debt levels and cumulative market share as at the end of 3Q20 (Source: BIS; CMMP)
The key message – seven perspectives
First, the US has the highest outstanding stock of debt in the world but deeper analysis is required to determine whether it has a “debt problem”
Second, in terms of debt ratios (debt/GDP), the US ranks outside the world’s highly indebted economies across the government, household (HH) and corporate (NFC) sectors
Third, the US is also one of only four developed market economies to have both HH and NFC debt ratios below the BIS maximum thresholds
Fourth, the current structure of US debt is the mirror image of the pre-GFC structure following the significant shift away from HH to government debt
Fifth, this changing structure reduces associated risks since the government faces different financial constraints to the HH and NFC sectors and cannot, as a currency issuer, become insolvent
Sixth, the risks associated with the level, growth and affordability of HH debt remain moderate in absolute and relative terms
Seventh, risks are elevated in the NFC sector, however, due to the recent rates of excess credit growth and affordability concerns but these risks are not exclusive to the US.
In short, risks associated with US debt are concentrated rather than systemic. Moreelevated risks exist in other developed and emerging economies where some of the highest rates of excess credit growth are occurring in highly indebted economies and affordability risks are rising despite the low interest rate environment. Investor attention should not be restricted to US debt simply due to its size – more immediate concerns lie elsewhere.
Does the US have a debt problem?
Outstanding US debt and market share by sector (Source: BIS; CMMP)
The US has the highest outstanding stock of total, government, HH and NFC debt in the world but deeper analysis is required to determine whether it has a “debt problem”.
The US has outstanding total, government, NFC, and HH debt of $61tr, $27tr, $18tr and $16tr respectively (as at end 3Q20). The US accounts for 29% of global debt alone and almost 50% together with China (see key chart above) and has market shares of 34%, 22% and 32% of global government, NFC and HH debt respectively (see chart above).
To understand the implications here and consider whether the US has a debt problem, CMMP analysis considers the stock of debt in the context of the level of GDP (debt ratios), its structure, its rate of growth and affordability.
Ranking of BIS reporting economies by total debt/GDP (Source: BIS; CMMP)
In terms of debt ratios (debt/GDP), the US ranks outside the world’s highly indebted economies in all sub-sectors. It is ranked only #18 in terms of total debt ratio for example (see chart above), and #22 and #12 in terms of NFC and HH debt ratios. In the case of government debt (129% GDP), the US is ranked higher, however, at #10 after Japan (235%), Greece (212%), Italy (172%), Portugal (146%), Belgium (137%), France (134%), UK (133%) and Spain (132%).
NFC and HH debt ratios plotted against BIS maximum threshold levels (Source: BIS; CMMP)
The US is one of only four developed market economies to have both HH and NFC debt ratios below the BIS maximum thresholds. The BIS considers HH and NFC debt ratios of 85% and 90% GDP to be threshold levels above which debt becomes a constraint on future growth. The BIS provides debt ratios for 22 developed and 21 emerging economies. As can be seen in the scatter diagram above, the US sits in the lower LH quadrant with a HH debt ratio of 78% and a NFC debt ratio of 84%. Germany, Greece and Italy are the only other developed economies to sit within the same quadrant.
Breakdown of outstanding US debt by sector (Source: BIS; CMMP)
The current structure of US debt is the mirror image of the pre-GFC structure following the significant shift away from HH debt to government debt. The share of HH debt peaked at 44% total debt in 2Q07 and fell to 27% by end 3Q20. In contrast, the share of government has risen from 26% to 44% over the same period.
As the Federal Reserve Bank of St Louis noted back in 2018, “The fall in household debt was primarily driven by the fall in mortgage debt that followed the housing crash. The surge in public debt, on the other hand, was partly driven by the large fiscal stimulus packages that were deployed to fight the Great Recession.”
The changing structure of US debt reduces associated risks since the government faces different financial constraints and cannot, as a currency issuer, become insolvent. HHs, NFCs and financial institutions are all “currency users” who face obvious constraints on their levels of debt. “Taking on too much debt can, and does, lead to bankruptcy, foreclosure, and even incarceration” (Kelton, 2020). In contrast, the US government, as a currency issuer, cannot become insolvent in its own currency since it can always make payments as they come due in its own currency.
In the seventh lesson from the money sector, I highlighted an article published by David Andolfatto of the Federal Reserve Bank of St Louis (4 December 2020). In line with my preferred financial sector balances approach, Andolfatto questions the “government as a household” analogy and notes that, “to the extent that government debt is held domestically, it constitutes wealth for the private sector.” From here, and more significantly, he argues that:
“…it seems more accurate to view the national debt less as a form of debt and more as a form of money in circulation…The idea of having to pay back money already in circulation makes little sense, in this context. Of course, not having to worry about paying back the national debt does not mean there is nothing to be concerned about. But if the national debt is a form of money, wherein lies the concern?”
“Does the National Debt Matter?” Federal Reserve Bank of St. Louis, December 2020
Trend in HH debt/GDP ratio over past 20 years (Source: BIS; CMMP)
Sixth, the risks associated with the level, growth and affordability of HH debt remain moderate in absolute and relative terms. High levels of household indebtedness were an important contributing factor to the GFC and subsequent recession. The HH debt ratio rose to a peak of 99% GDP in 1Q08 well above the 85% BIS threshold level. This ratio is 78% GDP today. Not only was the level of HH debt a matter of concern, but the pace of growth was sending clear warning signals too.
Rolling 3-year RGF for US HH sector over past 20 years (Source: BIS; CMMP)
CMMP analysis uses a relative growth factor to analyse the rate of growth in debt. This compares the 3-year CAGR of debt with the 3-year CAGR in nominal GDP. As can be seen in the chart above, the RGF for the US HH sector peaked at 7% in 1Q04, fell and then remained negative for 41 consecutive quarters from 2Q10 until the last reporting quarter (3Q20).
HH RGFs plotted against HH debt ratios for advanced BIS economies (Source: BIS; CMMP)
In the context of other developed economies, the risks of excess HH credit growth are much lower in the US than in Norway, Sweden, Canada, Switzerland, New Zealand and the UK. Each of these economies are experiencing excess HH credit growth (ie, RGF > 1) despite relatively high debt ratios that exceed the BIS threshold level of 85% GDP.
DSR (%) and deviation from 10Y average for advanced BIS economies (Source: BIS; CMMP)
In terms of affordability risk, the debt service ratio for the US HH sectors is low in absolute terms (7.6%) and in relative terms against its own 10Y average of 8.3% and against other developed economies.
Trend in NFC debt ratio over past 20 years (Source: BIS; CMMP)
Risks are elevated in the NFC sector, however, due to the recent rates of excess credit growth and affordability concerns but these risks are not exclusive to the US. The NFC sector experienced 33 consecutive quarters of a rising debt ratio since 1Q12 and at 84% GDP is very marginally below the recent peak in 2Q20. Note however, that while the current NFC debt ratio is high in the context of the US, it remains below the 90% BIS threshold.
Rolling 3-year RGF for US NFC sector over past 20 years (Source: BIS; CMMP)
Of more concern is the current 4ppt rate of excess NFC credit growth. As can be seen, the current RGF is close to previous peaks. This is despite fact that the absolute level of NFC debt is higher than at previous peaks in excess growth. The current RGF places the US among a group of seven developed economies experiencing excess NFC credit growth of more than 4ppt. Within this sample, Sweden, France, Canada, Switzerland and Japan are experiencing higher rates of excess growth despite having higher levels of NFC debt that exceed the BIS maximum threshold level of 90%.
NFC RGFs plotted against NFC debt ratios for advanced BIS economies (Source: BIS; CMMP)
Finally, the highest level of concern relates to the affordability of NFC debt. The current NFC debt service ratio of 47% is only marginally below its all-time high and is 8ppt above its 10-year average of 39%. Among developed economies, this places the US NFC sector among the higher risk sectors, albeit it below the NFC sectors in France, Canada and Sweden.
DSR (%) and deviation from 10Y average for advanced BIS economies (Source: BIS; CMMP)
Conclusion
The risks associated with US debt are more concentrated than systemic and relate mainly to the rate of excess NFC credit growth and its affordability.(Further incentive for the Federal Reserve to keep rates lower for longer?) From a global perspective, debt risks are more elevated in other developed and emerging economies. Some of the highest rates of excess credit growth are occurring in highly indebted economies and affordability risks are increasing within and outside this sub-set despite the low interest rate environment.
Investor attention should not be restricted to US debt simply due to its size – more immediate concerns lie eslewhere.
Please note that the summary comments and charts above are extracts from more detailed analysis that is available seperately.
