The household debt binge is over
Between 1945 and 2007, household debt grew at an average annualized rate of over nine percent, much faster than nominal income growth. This trend, which eventually hit a wall in 2007, represented a huge tailwind for household spending. Historically, household consumption has increased by roughly 0.2 percent for every one percentage point increase in household debt.
However, since the recession’s end, household debt has been growing at a much slower pace, less than one percent annualized. Going forward, it’s not clear whether older, still-indebted households (even if borrowing has slowed, debt levels are still well above the long-term average) can borrow at the same rate they did before the crisis. This means that even if wages pick up, consumers will be without the tailwind of debt-fueled consumption.
Market Realist – The household debt binge has hit a wall.
The above graph shows the average household credit card debt in the United States. As you can see, credit card debt nosedived since 2006 after the financial crisis. Part of the slump is due to defaults. Also, the crisis dented the confidence of households, which caused the fall in consumption and credit card debt.
Despite the amount of jobs being created and the collapse in oil (USO) prices, consumption has not picked up. This is because households have used the windfall to service debts instead of spend, which is one of the reasons we haven’t seen the much-anticipated pick-up in consumption.
Sectors like consumer discretionary (XLY), consumer staples (XLP), and retail (XRT) are likely to struggle if this trend continues. Safe havens like Treasuries (IEF) could gain if consumption remains low.
Lower consumption will have dampening effects on the economy. Find out the consequences in the next part of this series.