Credit Usage Rising But No Red Flags Yet

Posted by Jeffrey J. Roach, PhD, Chief Economist

Thursday, December 8, 2022

Should We Be Nervous About Rising Credit Usage?

Consumers are in a pinch: inflation is high and inflation-adjusted wage growth is weak. To support spending habits, consumers are tapping into credit and savings to bridge the gap between high prices and historical spending. Consumer credit figures for October were released yesterday, and the increase was not a surprise. Total credit usage rose by roughly $27 billion, supported mainly by auto sales and credit card usage. Credit card usage pushed revolving credit balances up by $10 billion from September and new student loans and auto purchases drove up non-revolving credit by $17 billion. Are these increases cause for concern? The answer is found in the household debt service ratio (DSR) which is the ratio of debt payments to disposable income.

According to the latest figures, the total household debt service ratio is approaching 10%, still 3 percentage points below the rate preceding the Great Financial Crisis. This level is not yet a cause for alarm, despite the expectations that the ratio will edge higher by the end of this year.

Our base case is the consumer will likely pull back spending in the coming months as economic uncertainty increases, the stock of savings diminish, and real wage growth remains sluggish. As we point out in the 2023 Outlook: Finding Balance, the domestic economy could dip into a mild recession sometime next year but likely avoid the deeper risks facing Europe.

View enlarged chart.


Wages have not kept up with high inflation and therefore, consumers have turned to credit to fuel purchases. So far, the consumer is in a comfortable spot to manage debt payments but this view is predicated on stable disposable income from a steady job market. As the Federal Reserve continues to tighten financial conditions, the consumer will feel the pressure on household balance sheets and will likely retrench in the New Year, suppressing discretionary spending.

Going forward, we are cautious on the broader consumer discretionary sector. The expected slowdown in 2023 will ultimately lead to a pullback in discretionary spending and sales at retailers. Large publicly traded retailers will not be immune from this pullback, though they may have levers to pull to subdue margin degradation. However, even if current earnings expectations for next year are correct, we see limited upside near term. The LPL Research Strategic & Tactical Asset Allocation Committee (STAAC) continues to hold a cautious view and an underweight to the S&P 500 consumer discretionary sector, from an asset allocation perspective.


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