Rising rates have sparked a new wave of concern that the U.S. consumer will finally run out of steam. Aided by a strong labor market and substantial fiscal stimulus during the pandemic, consumer spending has helped drive U.S. gross domestic product (GDP) growth, while other rate-sensitive parts of the economy have lagged. Many observers have worried that this strength is not sustainable, as the combination of higher rates and rising costs for goods and services has resulted in depleted aggregate savings, well below peak levels during the COVID-19 pandemic. (As former U.S. Federal Reserve [Fed] economist Claudia Sahm pointed out in a recent Bloomberg commentary, household liabilities have also declined in the post-pandemic period.1)
We would note, instead, that any observations regarding the health of the U.S. consumer require far more nuance than simple “good” or “bad” assessments. Here, we look at some important indicators, and their implications for the state of consumers’ financial health.
Credit-Card Delinquencies
News reports (including a recent Washington Post piece2) have cited rising delinquency rates on credit cards and car payments as a sign of growing stress on consumers’ pocketbooks.2 However, those headlines often obscure some important details, including the fact that many delinquency rates, while higher than their mid-COVID-19 lows, are still well below historic averages. Still, there are some pockets of consumers (particularly those whose credit is in the subprime category) that are struggling, even as prime loans continue to perform very well.
More recently, commentary from Macy’s and other U.S. retailers on second-quarter earnings calls has raised new questions about consumers’ financial wherewithal, as they indicated that year-over-year credit-card delinquency rates are still rising, as borne out by data from major credit-card issuers (see Figure 1).
Figure 1. Credit-Card Delinquency Rates Have Tracked Higher in Recent Months
However, there are early signs that this trend may be starting to ease. U.S. credit-card delinquency formation (the year-over-year change in 30-day delinquency rates) has leveled off for a number of major credit-card issuers and has actually improved for Bread Financial (parent of Comenity Bank), the second largest retail private-label card issuer. Stable delinquency formation is an important forward indicator of consumer credit, and we expect this measure to remain steady for Bread and other credit-card firms as long as U.S. weekly jobless claims, a major signal of consumer financial health, remain below 300,000.
Rising interest rates, and their effect on households’ ability to service consumer debt, have become another area of concern. But closer consideration of the issue shows us that rising rates may not impact the consumer as much as one might think. Credit-card interest rates after the global financial crisis of 2008–09 (GFC) have had a minimal direct impact on U.S. consumer monthly cash flows, for example.
Why? Because most consumer debt payments don’t move directly with interest rates. Even U.S. credit cards, where interest rates can move, more closely resemble fixed-rate loans than a loan that adjusts with the fed funds rate. The minimum monthly payment for a credit card is less sensitive to changes to the fed funds rate than what most would perceive, while the Credit Card Accountability Responsibility and Disclosure Act (CARD Act) of 2009 made it essentially illegal for credit-card issuers to impose sharp, sudden rate increases (a common practice pre-GFC).3
Financial Obligations
Figure 2. U.S. Households’ Financial Obligation Ratios Remain Well Below Historic Highs
Investment Implications
Figure 3. Spreads on Auto-Loan ABS Have Widened Versus Corporate Bonds
Source: Bloomberg. Data as of September 23, 2023. Indexes: Bloomberg AA ABS 1-3 Year Index (prime and subprime fixed-rate auto loan segments) and the ICE BofA 1-3 Year A-Rated Corporate Index (Corp A). One basis point is equal to one one-hundredth of a percentage point.
Past performance is not a reliable indicator or guarantee of future results. For illustrative purposes only and does not represent any specific portfolio managed by Lord Abbett or any particular investment. Indexes are unmanaged, do not reflect the deduction of fees or expenses, and are not available for direct investment.
As for credit-card ABS, the pool of cardholders in these products are structurally more established borrowers and more resilient than the pool of cardholders in most card lenders’ portfolios in aggregate—so the recent worsening credit-card credit metrics being reported at the company level are not fully representative of the ABS, which continues to materially outperform. The developments described above may present an opportunity for investors to add ABS to their portfolios, as spreads appear to be pricing in a more significant economic downturn than other asset classes.
Ultimately, the strength of the job market mentioned earlier, as well as limited sensitivity to interest rates for many consumers, lead us to believe that the U.S. consumer may fare well even in a modest economic downturn, and that many concerns have been premature if not outright wrong. As we noted earlier, not all segments of the consumer sector are holding up well, and some challenges may persist (for example, many Americans will have to resume making student loan payments as a government forbearance program expires). Still, the overall picture leads us to believe that the broad universe of consumer ABS is likely to perform well in a variety of outcomes.
We believe that overly pessimistic views about the health of the U.S. consumer have led to a compelling investment opportunity in ABS, even as performance dispersion among consumers leads to relative value opportunities.