State of the Consumer 3Q 2024: A soft landing for the economy and consumer debt

As we head into the final quarter of the year, the state of the consumer is strengthening, with strong employment data, inflation subsiding, rate cuts, and delinquencies normalizing. Despite these trends, the cost of capital for the average household remains relatively high and?won’t improve until we get?additional rate cuts. On balance, things are improving slightly but there remains uncertainty.?

QUARTER IN REVIEW:?

Positives

• Interest rate cut:?A 0.5 percent cut is better than a 0.25 percent cut, and?any?cut is better than no cut at all. Repayments for credit cards, car loans, and HELOCs will decrease. New mortgage originations are expected to rise, despite inflation still being above target. We expect a continued reduction in the relative growth in the cost of goods like energy, food and transportation. But the east coast dockworkers strike is a recent example of a risk to subsiding inflation.

• CFPB late fees revisited:?The CFPB’s proposal to cap credit card late fees at $8 could save Americans $10 billion a year. However, this would reduce banks' income, leading to potential pullback from lending to subprime customers or other repricings if late fee revenue no longer justifies the risk.

• Job market stabilisation:?Unemployment remains low at 4.1 percent, with 254,000 jobs added in September. This marks 35 consecutive months of a sub-4.3 percent rate, stabilising after pandemic highs. As unemployment stabilizes, inflation is expected to moderate.

• Banks pull back:?Tighter underwriting has led to lower competition and reduced costs for acquiring customers. Banks are focusing on borrowers with stronger credit, leading to fewer defaults and more opportunities to cross-sell products.?The Fed reported that the median original credit score for new accounts has climbed by 21 points over the eight most recent quarters, with the number of new accounts originated in Q2 10.3 percent lower than one year earlier.

• Delinquencies normalize:?While still above pre-pandemic levels, delinquency rates have begun to stabilise, especially in the subprime sector, with other risk groups seeing minor increases.?In Q2, the Fed reported the number of outstanding credit card balances that were 30, 60, or 90 or more days past due dropped by 24, 23 and 18 basis points, respectively – the largest quarterly decrease in three years, albeit from previous 12-year highs, and in line with seasonality.
• Debt-income ratio remains low:?Household debt service ratio was at 11.5 percent in Q2 according to the St. Louis Fed. While that is the highest it has been since Q1 2020, it is increasing from a historically low base during COVID-19. Overall, debt payments have been trending down since 2008 while household income has been growing. The current ratio is one of the lowest since 2000.

Negatives

• Minimal impact on credit card repayments:?Though any rate cut helps, it barely impacts credit card payments. A quarter-point rate cut saves just $25 on a $10,000 balance. Meanwhile, consumer debt remains at historically high levels—$5.09 trillion in July—making it clear that debt is not shrinking, nor is it becoming significantly cheaper.

• Mortgages largely unaffected: The cost of a new 30-year fixed loan remains around 6 percent, changing inconsequentially in September since rates had already dropped in May ahead of the Fed’s Q3 cut. Most homeowners already have lower rates, so refinancing benefits only a small number. Fewer than 10 percent of Americans are moving each year – it was one-in-five in the 1960s, according to an Axios report – so a reluctance to move further limits housing supply. According to the Dallas Fed, 96 percent of residential mortgage debt in the U.S. is in the form of long-term fixed debt of at least 10 years.
• Auto loans remain elevated: Rates on new car loans may drop slightly, but the impact will be minimal. The average financing for a new vehicle is still $178 more per month than in 2019, erasing savings from interest rate cuts.

• BNPL loans not reported to bureaus:?The inconsistency in reporting Buy Now, Pay Later loans to credit bureaus creates blind spots for lenders assessing risk. Consumers may not get credit for timely payments, or worse, may harm their credit scores by lowering their average age of trades when loans are paid off.

• Basel III capital requirements:?The Basel III Endgame proposal would require banks to increase capital to ensure safety, but critics argue it could restrict lending, including mortgages, car loans and small-business financing, hurting working families. Federal Reserve Board discussions have stalled, with further revisions under review.

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Our take and what’s ahead

Banks have been under pressure this year through compressed net interest margins, decreased loan volumes and high delinquency rates. The outlook is improving, but earnings are expected to show year-over-year declines for most of the big banks, who have made money on deposits.?With inflation heading in the right direction, unemployment remaining low and delinquencies stabilizing, there are reasons to be positive for the consumer banking outlook.

For consumers, Q4 will be better, even if it doesn’t necessarily feel like it. Monthly payments will come down for most consumers and home ownership may begin to open up for first-time buyers. For existing homeowners looking at refinancing options in the coming year, possibilities are at least now on the horizon.?

Subprime consumers remain in a tenuous state, with at least one-third of Americans still living paycheck to paycheck, but reduced?late?fees, extended periods of low unemployment and cheaper costs of lending are all small steps in the right direction, even if the savings are small.

On balance, things are improving for the everyday consumer and for consumer lenders. However, with continued turmoil in the middle east,?a presidential election and supply chain disruption, financial pressures could be exacerbated before year end impacting inflation, interest rate decisions and beyond.