The consumer’s holding power may decrease to Investing.com’s credit

As the economic landscape changes, the resilience of consumer spending appears increasingly tied to the availability and cost of credit.

With savings largely depleted from the pandemic and a weakening labor market casting doubt on future income growth, the role of credit is becoming increasingly crucial, analysts at Wells Fargo said in a note dated Monday.

“The overall weakness of July’s jobs report raised questions about whether the policy environment has remained too restrictive for too long, yet recent consumer spending numbers continue to be stronger than expected,” they analysts said.

Real personal consumption expenditures (PCE) rose in the second quarter, rising at an annual rate of 2.3 percent on the back of strong purchases of durable goods and steady spending on services. Early indicators point to a strong start to the third quarter as well.

However, the slowing pace of hiring in July, along with other signs of a weakening labor market, signal that income growth could be under pressure, potentially weighing on consumer spending in the near term.

If the labor market had cooled earlier, households would have been better prepared to deal with job losses or slower income growth. Now, with savings depleted, credit has taken on a greater role in supporting consumer spending.

Revolving consumer credit, especially credit card debt, has outpaced other forms of household debt this economic cycle. However, the pace of borrowing has slowed dramatically in 2024, with outstanding revolving debt falling in two of the past three months.

This trend, countered by rising delinquencies and higher credit costs, suggests that credit is becoming less accessible, although household belt-tightening may also be a contributing factor.

Total revolving credit is now more than 20% above pre-pandemic levels and has grown nearly eight times faster this cycle than the last, raising concerns about over-leveraging.

However, when adjusted for higher income, the increase in revolving credit appears less alarming. The credit-to-income ratio remains below pre-pandemic levels, although it’s important to note that this ratio doesn’t take into account who holds debt versus who earns income.

This distinction is critical, especially given the higher costs of servicing debt today. Delinquency notices are on the rise, with more than 9 percent of credit card borrowers remaining 30 days behind on their payments — the highest delinquency rate among major categories of household debt.

While credit cards are the fastest growing category of debt, mortgage debt remains the largest, accounting for more than 70% of all household debt. Households that refinanced during the pandemic benefited from lower fixed rates, with the effective rate on all mortgages outstanding coming in at just 3.9% in Q2, nearly 300 basis points below the average 30-year conventional mortgage rate years, by 6.8%. These lower rates have kept mortgage delinquencies below pre-pandemic levels.

In the mid-2000s, many homeowners took advantage of rising home values ​​with home equity loans or lines of credit (HELOCs), contributing to the housing bubble and financial crisis.

Today, while the use of HELOCs has increased, home prices have generally outpaced the growth of these loans, keeping homeowner equity near historic highs. This equity provides a significant source of liquidity, allowing homeowners to support expenses.

While HELOCs aren’t as cheap as they were a few years ago, they remain more affordable than credit card debt, with rates typically just a few percentage points higher than the current 30-year mortgage rate.

This makes HELOCs a more attractive option for higher spenders, although they carry the risk of using homes as collateral.

Despite high credit costs, demand for credit card loans remained strong in Q2. However, as economic conditions deteriorate and delinquency rates rise, banks are becoming increasingly cautious.

The Federal Reserve’s latest survey of loan officers reveals that banks are tightening consumer credit limits and raising minimum credit scores required for new credit card loans.

In contrast, banks show an increased willingness to grant consumer loans in installments, especially for major purchases of durable goods such as furniture or household appliances.

While the latest data may seem unremarkable, with banks willing to lend at 0.0%, this is a significant improvement over the negative readings seen 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 by assets, particularly real estate.

However, this is cold comfort for the 34% of households that do not own a home. For low-income tenants, the situation is particularly dire.

These households are more likely to carry revolving credit card balances, which have become increasingly expensive in today’s high-rate environment.

The situation is exacerbated by the fact that lower-income households tend to spend a larger share of their income on non-discretionary items such as gas and food, where prices have risen faster than broader inflation.

This has contributed to higher 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 conclude that they have not been affected. The increasing reliance on credit, especially among lower-income households, underlines the precariousness of the current economic situation.

As access to credit becomes tighter and more expensive, the resilience of consumer spending may ultimately depend on how well households can navigate this challenging environment.