- Fixed Income Portfolio Manager
- About Us
- My Account
The views expressed are those of the author at the time of writing. Other teams may hold different views and make different investment decisions. The value of your investment may become worth more or less than at the time of original investment. While any third-party data used is considered reliable, its accuracy is not guaranteed. For professional, institutional, or accredited investors only.
The Federal Reserve’s (Fed) rate hikes over the last year have led to a sharp increase in borrowing costs, raising concerns that a consumer-driven economic recession could be looming. Recent bank failures are likely to result in tighter lending standards or a contraction in available credit to consumers, which is generally negative for overall consumer health. While I do anticipate pockets of weakness, I also observe some mitigating factors that could keep US consumption elevated and support economic growth, which could be further bolstered if the Fed deviates from its “higher for longer” policy rate trajectory in the pursuit of financial stability.
The Fed’s data on consumer credit shows that credit card limits have grown steadily, along with a pickup in utilization rates — the percentage of a credit card limit used by a borrower. But credit utilization still remains below pre-pandemic levels and well below the heights reached during the stress of the global financial crisis (GFC). It’s important to point out that credit card balance data is the sum of all credit card borrowers’ most recent statement balances; balances that are paid in full or partially paid each month are also included in this data. To better ascertain actual consumer behavior, I look at monthly payment rates (MPR) from credit card companies. MPRs are high (~40%) and have grown as limits have increased over time (Figure 1).
Bottom line: While consumer performance is softening, consumers are paying all or a portion of their credit card balances in a timely manner; delinquencies are low.1 Yes, credit card balances are higher, but in my view, much of this reflects the evolution to a cashless society, as opposed to a worrisome trend of consumers taking on unmanageable debt burdens.
Roughly speaking, baby boomers — those born between 1946 and 1964 — account for around a fifth of the US population. But boomers represent an outsize proportion of consumption; almost every other dollar spent is spent by a baby boomer. Benefiting from a combination of favorable economic conditions and time, baby boomers hold the largest share of assets in the US in the form of excess savings, real estate, and equities.
In this new, higher interest rate environment, these assets are a source of additional income and security, with excess savings now generating 3.5% – 4.5% in interest rather than 0%. Boomers also have a high rate of homeownership. Many of them may own their homes outright, but those that don’t probably benefit from locked-in, ultra-low, fixed mortgage rates. No such luck for renters, who have instead been exposed to rising costs as property owners increase rents.
All of this means that baby boomers on the wealthier side of the spectrum tend to have robust balance sheets — bolstering their ability to access credit even as standards tighten. Those tighter lending standards are more likely to impact subprime borrowers, who are perceived as riskier. In short the cohort that spends the most is likely to continue spending the most — driven by the tailwinds of higher rates on income from savings and asset appreciation.
The subprime consumer has been most adversely impacted by higher inflation given that their consumption basket weighs more heavily to fuel, food, and shelter. While some of these pressures have subsided, this consumer will continue to feel the strain of ongoing rent growth and the impact of higher rates on auto loans and other short-term debt. But this is somewhat offset by wage growth and a tight labor market, which should support subprime consumers for longer.
Many have noted the tightening in credit lending standards (which may tighten even further due to the banking sector turmoil), to which the subprime consumer cohort is most exposed. In my view, auto and consumer loan lenders originated too many questionable loans to lower-tier borrowers in late 2021 and 2022. As performance deterioration started to materialize in the form of late payments and increased delinquencies, lenders responded by tightening their standards throughout 2022, moving higher up in quality and slowing originations.
Subprime borrowers may have been negatively impacted by being unable to access as much credit in the latter half of 2022 but will benefit from avoiding the rising costs of servicing that debt and thereby decreasing the risk of delinquencies. As such, I expect materially better performance of 2023 underwriting despite continued headwinds.
These mitigating factors may keep consumer spending fairly robust despite higher rates. However, if the unemployment rate starts to pick up, the priority of payments will be critically important to the performance of consumer debt-related assets.
I suggest that allocators focus their investments in areas that are the highest priority for consumers to repay when cash is tight. Mobile phones, auto loans, mortgages, and, to a lesser extent, general purpose cards remain in this category. Student loans, consumer loans, and store-branded credit cards are some of the lowest priority debts, and therefore have less investment appeal.
17.67% of credit card balances were 90+ days delinquent as of 31 December 2022, according to the New York Fed Consumer Credit Panel, compared to an average of 9.34% since 31 March 2003.
US regional banking sector updateContinue reading
Financials amid rising dispersionContinue reading
State of the credit markets: Does cash rule everything around us?Continue reading
FX outlook: Is USD exceptionalism withering away with the Fed hiking cycle nearing an end?Continue reading
Private credit in a new regimeContinue reading
US regional banking sector update
We explore how banking regulation and legislation could impact US regional banks, including highlighting the potential for M&A activity and for dispersion to drive long/short opportunities.
Financials amid rising dispersion
We explore why we believe dispersion across stocks, sectors, and geographies is supporting numerous secular themes in long/short investing in financials.
State of the credit markets: Does cash rule everything around us?
Fixed Income Portfolio Manager Brij Khurana outlines the state of the credit market today, compares historical periods of quantitative easing, and warns credit investors of cash scarcity in the near future.
FX outlook: Is USD exceptionalism withering away with the Fed hiking cycle nearing an end?
Discover the status of the USD today, learn where the greenback may be headed going forward, and understand why.
Private credit in a new regime
We explore how a shifting macro backdrop, ongoing banking crisis, and evolving competitive dynamics may create opportunities across private credit markets.
Credit market outlook: Expect greater opportunities in back half of 2023
Against a backdrop of elevated recession risks and banking-sector stress, Fixed Income Portfolio Manager Rob Burn identifies relative-value sector opportunities in the credit market.
Inflation loosens its grip, but bank turmoil could put the squeeze on US growth
US Macro Strategist Juhi Dhawan weighs the benefits of disinflation for consumers and companies against the risks of a credit crunch brought on by the recent bank crisis.
Global high yield: Attractive entry points could soon emerge
Fixed Income Portfolio Manager Konstantin Leidman shares his outlook for high-yield fixed income for the rest of this year and beyond.
Did the Fed just make a policy error?
Did the Fed just make a policy error? All things considered, Fixed Income Portfolio Manager Jeremy Forster thinks the answer is yes. Learn why and what the implications could be.
How do bank failures impact fintech?
Global Industry Analyst Matt Ross analyzes the ways in which recent US bank failures could impact the fintech sector in public and private markets.
Three macro assumptions that could be just plain wrong
Fixed Income Portfolio Manager Brij Khurana offers his non-consensus take on three entrenched, but potentially flawed, beliefs in today's market environment.