U.S. Fixed Income

Consumers Are Financially Strong, But Inflation Looms

July 11 2022
Transcript

As a corporate credit analyst covering the U.S. banking industry, I closely monitor the aggregate financial health of consumers. Today, pandemic-related government stimulus and forbearance on certain loan payments combined with a robust labor market have resulted in consumer balance sheets that are stronger than before the pandemic.

Along the onset of the pandemic, consumers took advantage of stimulus and forbearance to pay down debt, save, and spend, in almost equal amounts. Consumer lenders have benefited, as shown by exceptionally low default rates and high payment rates—which are defined as the percentages of outstanding balances paid off each month.

The average balance in consumer checking accounts across the income spectrum is higher than before the pandemic. 

Consumers are releveraging, with aggregate credit card debt recently rising above pre-pandemic levels. At current loan growth rates, consumers will return to pre-pandemic trend growth in loans in the coming quarters.

But the wildcard has become inflation. Prices have been rising faster than wages, eroding consumer purchasing power.

Retailers are indicating that discretionary purchases are lower, and less expensive private-label goods are gaining market share. This appears to show that consumers are shifting their spending habits as they adapt to higher inflation.

If inflation stays elevated, consumers at all income levels will need to lean more heavily on their savings to fund purchases, reducing average checking account balances.

On the other hand, a swift return to lower levels of inflation that are more typical of the last 20 years would give consumers more room to maneuver in managing their household finances.

What does this imply for the credit quality of U.S. banks going forward? In our view, their consumer lending businesses, including credit cards, home mortgages, and auto loans, will deteriorate from today’s very healthy conditions if inflation stays high and forces consumers to meaningfully draw down on their pandemic-era savings. However, this process of normalization will take time, and with lenders starting in a strong position, there is ample room in capital and loan loss reserves to absorb higher default rates.

The key indicators that we are watching going forward include consumer delinquencies and trends toward later payments as well as any movement in payment rates toward lower levels that are more typical of historical averages.

Key Insights

  • Pandemic-related stimulus combined with a robust labor market have resulted in consumer balance sheets that are stronger than before the pandemic.
  • Consumers are releveraging, with aggregate credit card debt recently rising above pre-pandemic levels.
  • However, if inflation stays elevated, consumers will need to lean more heavily on their savings to fund purchases, reducing average checking account balances.

Important Information

This material is provided for informational purposes only and is not intended to be investment advice or a recommendation to take any particular investment action.

The views contained herein are those of the authors as of June 2022 and are subject to change without notice; these views may differ from those of other T. Rowe Price associates.

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Information contained herein is based upon sources we consider to be reliable; we do not, however, guarantee its accuracy. Actual future outcomes may differ materially from any forward-looking statements made.

Past performance is not a reliable indicator of future performance. All investments are subject to market risk, including the possible loss of principal. All charts and tables are shown for illustrative purposes only.

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