Navigating the Credit-Driven Economy: The Fragile Balance of Consumer Spending Amidst Rising Debt

As we observe the evolving economic landscape, it becomes evident that the resilience of consumer spending is increasingly intertwined with the dynamics of credit availability and cost. In a period where pandemic-era savings have dwindled and the labor market shows signs of softening, the role of credit in sustaining consumer spending cannot be overstated.

Critical role credit plays in the current economic environment. With the July jobs report reflecting broad weakness, questions arise about the potential overreach of restrictive policies. Yet, consumer spending has remained surprisingly robust, as evidenced by a 2.3% annualized growth in real personal consumption expenditures (PCE) during the second quarter, driven by strong purchases of durable goods and consistent services spending.

However, the slowing pace of hiring in July, along with other labor market indicators, suggests that income growth may face pressure, potentially impacting consumer spending in the near future. Had the labor market cooled earlier, households might have been better positioned to manage job losses or slower income growth. Now, with savings largely depleted, credit has assumed a more prominent role in maintaining consumer spending levels.

One concerning trend is the significant rise in revolving consumer credit, particularly credit card debt, which has outpaced other forms of household debt during this economic cycle. Despite this, the pace of borrowing has slowed in 2024, with outstanding revolving debt declining in two of the past three months. This slowdown, coupled with rising delinquencies and higher credit costs, suggests that credit is becoming less accessible. Household belt-tightening may also be a contributing factor.

Total revolving credit now stands over 20% above pre-pandemic levels, growing nearly eight times faster in this cycle than the previous one, raising concerns about potential over-leveraging. However, when adjusted for higher incomes, the rise in revolving credit appears less alarming. The credit-to-income ratio remains below pre-pandemic levels, though it is essential to consider who holds the debt versus who earns the income.

This distinction is crucial, particularly given the higher costs of servicing debt today. With over 9% of credit card borrowers falling 30 days behind on payments, we are witnessing the highest delinquency rate among major household debt categories. This indicates that the rising costs of credit are beginning to strain household finances, particularly for those relying heavily on revolving credit.

While credit cards remain the fastest-growing debt category, mortgage debt continues to dominate, accounting for over 70% of all household debt. Households that refinanced during the pandemic have benefited from lower fixed rates, with the effective rate on all outstanding mortgage debt at just 3.9% in Q2, nearly 300 basis points below the average new 30-year conventional mortgage rate of 6.8%. These lower rates have helped keep mortgage delinquencies below pre-pandemic levels.

In contrast, the mid-2000s saw homeowners tapping into rising home values through home equity loans or lines of credit (HELOCs), contributing to the housing bubble and subsequent financial crisis. Today, while the use of HELOCs has increased, home prices have generally outpaced the growth in these loans, keeping homeowners’ equity near all-time highs. This equity provides a significant source of liquidity, allowing homeowners to sustain spending.

Despite higher credit costs, demand for credit card loans remained strong through Q2. However, as economic conditions deteriorate and delinquency rates rise, banks are becoming more cautious. The Federal Reserve’s latest loan officer survey indicates that banks are tightening consumer credit limits and increasing the minimum credit scores required for new credit card loans.

In contrast, banks are showing increased willingness to extend consumer installment loans, particularly for significant durable goods purchases. Although the latest data may seem unremarkable, the fact that bank willingness to lend is now at 0.0% represents a significant improvement from the negative readings observed over the past year, signaling a cautious recovery in lending.

The current credit environment highlights a growing divide. Credit remains available and relatively affordable for loans secured against assets, particularly real estate. However, this is of little comfort to the 34% of households that do not own a home. For low-income renters, the situation is particularly dire. These households are more likely to carry revolving credit card balances, which have become increasingly expensive in the current high-rate environment.

The situation is exacerbated by the fact that lower-income households tend to allocate a larger portion of their income to non-discretionary items such as gas and groceries, where prices have risen faster than broader inflation. This has contributed to the rising credit card delinquency rates among lower-income and younger borrowers.

While consumers have continued to spend despite rising interest rates, it would be a mistake to assume that they have been unaffected. The increasing reliance on credit, particularly among lower-income households, underscores the precariousness of the current economic situation. As access to credit becomes more restricted and expensive, the sustainability of consumer spending may ultimately hinge on households’ ability to navigate this challenging environment.

I view these trends with a mixture of caution and pragmatism. While the resilience of consumer spending has been impressive, the growing dependence on credit, especially among vulnerable populations, raises concerns about the long-term health of the economy. As we move forward, it will be crucial for both policymakers and financial institutions to carefully monitor these developments and adapt strategies to support sustainable economic growth.