U.S. Consumer Debt: Headwinds To Achieving A Step-Up In Growth

by: Manning & Napier

Since exiting the 2009 recession, the U.S. economy has been humming along at a rather slow pace, averaging 2.2% real annual GDP growth over the last five years. During this time, economic data has generally trended higher, labor markets have gradually healed, and the U.S. consumer has modestly deleveraged, leading to a slight improvement in household finances. Many market participants expect that the U.S. economy is now on the verge of escape velocity and that rate hikes are imminent. There are, however, several headwinds to achieving a step-up in growth, and our view remains that the U.S. economy is still in a slow growth trend.

While the U.S. consumer has seen noticeable deleveraging since the global financial crisis, consumer debt levels are still elevated relative to other periods in history, as well as relative to income. Household debt can be summed up as mortgage debt plus consumer credit. Much of the aforementioned improvement seen in consumer balance sheets can be attributed to reductions in mortgage obligations. These were primarily driven lower by charge-offs/defaults, while the Federal Reserve's zero interest-rate policy drove down monthly debt burdens as well.

As a result of lower interest rates that have been in place since the global financial crisis, the consumer's Debt Service Ratio and broader Financial Obligations Ratio - measures of total required household debt payments to total disposable income - are now near all-time lows. If the Fed indeed embarks on a path of policy normalization, as is currently expected by the financial community, the cost of credit will rise. We believe that the higher level of interest rates could potentially create a large headwind to a consumer that still has high levels of debt.

We find it interesting and also possibly worrisome that in the last several years the growth in consumer credit has come from two areas which are now seeing increased delinquencies. These areas are non-revolving student and auto loans, and they have both contributed to fairly robust consumption growth in the economy as the effects of the financial crisis gradually wore off. With delinquencies in these two loan categories rising of late, we believe this could be a sign that there is still pronounced weakness in parts of the consumer landscape. Therefore, higher interest rates may accelerate some of the stresses we are already seeing.

Also weighing on the consumer is a lack of meaningful income growth. While the U.S. is farther along in the economic cycle and the labor market has tightened, a meaningful pickup in wages - typical at this stage of previous cycles - has not yet materialized. Though wage growth is accelerating in some sectors, the strongest growth has been concentrated in the lowest paying industries. Broadly, year-over-year average weekly earnings growth has been on the rise, yet remains far below the growth rate seen prior to the recession. Average hourly earnings growth has also been on the lackluster side, rising less than 2% year-over-year on average for the last five years, barely above average headline inflation over the same time period.

We believe that this combination of subdued wage growth, coupled with still elevated household debt levels - drivers of consumer retrenchment during the recession - have been and will likely remain headwinds to consumer spending. As a result of these wage and debt dynamics, we expect that modest levels of consumer spending will translate into still modest growth for the U.S. economy.

While this remains our outlook, evidence that wage growth is picking up and/or a long-awaited return of investment and capital spending by U.S. corporations would likely change our views in a more positive direction. As the next year unfolds, we will be on the lookout for these indicators given their outsized impact on our U.S. macro outlook.