Craig P. Holke Investment Strategy Analyst WEEKLY GUIDANCE ON ECONOMIC AND GEOPOLITICAL EVENTS December 18, 2018 Are Rising Household Debt Concerns Warranted? Key takeaways» Concerns have risen about the levels of U.S. household debt and whether debt at these levels will have a negative impact on the economy.» Mortgage debt remains below the previous peak. Auto loans have increased significantly and delinquencies have risen. Credit card debt growth has slowed and delinquencies remain below pre-recession levels. What it may mean for investors» U.S. household debt growth has moderated and delinquencies remain mostly in check. We do not believe debt at these levels or growth rates poses a threat to our forecast for solid economic growth into 2019. U.S. household debt was a significant contributor to the Great Recession of 2008-2009. The economy had been boosted by households taking on too much debt, including speculation in the housing and real estate market. The recovery following the recession was then hampered by households drastically cutting spending, increasing savings, and attempting to put their personal balance sheets back in order. Household debt levels have continued to rise in terms of absolute levels. This has raised concerns about the effect this may have on household spending and the economic growth. The Federal Reserve Bank of New York tracks household debt through the quarterly Household Debt and Credit Report, created by the New York Fed Consumer Credit Panel in conjunction with Equifax. While absolute levels of household debt have risen to new highs, with the exception of mortgage debt, we do not believe debt at these levels poses a significant threat to the U.S. economy at this time. Chart 1 depicts the year-over-year growth in household mortgage, auto loan, and credit card debt. Prior to the Great Recession, mortgage debt grew; yet, the pace of this growth has declined as mortgage rates and home prices continued to rise. Being sensitive to interest rates, auto loan growth continued to decline as the Federal Reserve (Fed) began raising rates in mid-2004. Credit card debt growth continued to increase later in the cycle as households finance greater spending. 2018 Wells Fargo Investment Institute. All rights reserved. Page 1 of 6
Chart 1. Auto and credit card debt growth continues to slow 25% 20% 15% 10% 5% 0% -5% -10% -15% Q1 2004 Q3 2004 Q1 2005 Q3 2005 Q1 2006 Q3 2006 Q1 2007 Q3 2007 Q1 2008 Q3 2008 Q1 2009 Q3 2009 Q1 2010 Q3 2010 Q1 2011 Q3 2011 Q1 2012 Q3 2012 Q1 2013 Q3 2013 Q1 2014 Q3 2014 Q1 2015 Q3 2015 Q1 2016 Q3 2016 Q1 2017 Q3 2017 Q1 2018 Q3 2018 Auto loan Mortgage Credit card Sources: New York Fed Consumer Credit Panel/Equifax, Bloomberg, Wells Fargo Investment Institute. Notes: Shaded area designates recession as defined by the National Bureau of Economic Research. Data reflects year-over-year debt growth and is from the first quarter of 2003 through the third quarter of 2018. Debt growth turned negative during and right after the recession as households reduced spending and attempted to improve their personal finances. This was done voluntarily through reduced spending and refinancing, and involuntarily, through defaults and foreclosures. We then see the typical increase in debt accumulation while the economy and labor market recover. Auto loan growth was the first to recover as low interest rates and incentives from auto makers induced purchases. Credit card growth was slower to mend as households maintained discipline while paying down outstanding debt. Mortgage debt growth has been the slowest to recover. In fact, mortgage debt is the only major category of household debt that has not reached a new peak in terms of absolute level of debt. We have now seen auto loan and credit card growth slow while the expansion has matured. This makes sense, in our opinion, as both forms of borrowing are sensitive to Fed interest rate hikes. Mortgage debt growth has leveled out, not reaching the peak seen during the real estate bubble prior to the Great Recession. 2018 Wells Fargo Investment Institute. All rights reserved. Page 2 of 6
Rising defaults may pose an issue in the future Concerns arise that households take on more debt than they are able to afford and then become unable to repay their debts. This is also a sign that spending, which drives economic growth, will decline. Chart 2 shows the amount that each form of debt has been delinquent for at least 90 days. Pre-recession, these delinquencies had remained stable for the most part with the exception of mortgages as the housing market began to feel strains. As a mirror image of debt growth, delinquencies rise during and immediately following recessions, since slower economic growth and loss of jobs affects the ability of households to pay their debt. Chart 2. Defaults have been rising in auto loans and credit cards 16% 14% 12% 10% 8% 6% 4% 2% % Q1 2003 Q3 2003 Q1 2004 Q3 2004 Q1 2005 Q3 2005 Q1 2006 Q3 2006 Q1 2007 Q3 2007 Q1 2008 Q3 2008 Q1 2009 Q3 2009 Q1 2010 Q3 2010 Q1 2011 Q3 2011 Q1 2012 Q3 2012 Q1 2013 Q3 2013 Q1 2014 Q3 2014 Q1 2015 Q3 2015 Q1 2016 Q3 2016 Q1 2017 Q3 2017 Q1 2018 Q3 2018 Auto loan Mortgage Credit card Sources: New York Fed Consumer Credit Panel/Equifax, Bloomberg, Wells Fargo Investment Institute. Notes: Shaded area designates recession as defined by the National Bureau of Economic Research. Data reflects the amount of debt type that has been delinquent for greater than 90 days and is from the first quarter of 2003 through the third quarter of 2018. Economic recovery and expansion allows for delinquencies to decline as household finances improve with the growing economy and labor market. Mortgage defaults currently remain low, with higher lending standards playing a key role. The current median credit score at the origination of a mortgage is 758 significantly higher than the low of 707 at the end of 2006. Auto loan delinquencies are approaching levels seen following the recession. Lending standards remained lower in auto loans and are now experiencing higher defaults. Credit card defaults are perpetually higher. While they have trended higher, they remain below pre-recession levels and are not showing signs of accelerating. 2018 Wells Fargo Investment Institute. All rights reserved. Page 3 of 6
Market implications Rising debt levels are, in and of themselves, not a problem. The issue can arise when debt levels rise faster and higher than households are able to afford. Too much debt and consumers have less extra money to spend and, as a result, drive economic growth. Mortgage debt is the far largest component of household debt and is able to pose a systemic risk to the U.S. economy, as was seen in the Great Recession. Yet, levels of debt and growth rates remain below the previous peak, and tighter lending standards are limiting delinquencies. Auto loan debt had grown significantly, but has slowed as interest rates have risen and dealer incentives were reduced. The higher level of delinquencies is concerning for the signal it sends about future consumer spending. However, auto loans have solid collateral in the auto itself and do not pose a similar threat to the overall economy as mortgage debt did in the last recession. Credit card debt is very cyclical in nature. The growth rate has declined (which is positive) and delinquencies remain below even those prior to the last recession. As such, we do not believe that, even though most categories have risen to new highs, household debt poses a significant threat to our current outlook for still strong, yet slowing economic growth in the U.S. This growth may be able to continue supporting solid levels of household saving and spending and to contribute to our favorable outlook on U.S. large-cap and mid-cap equities. This growth will also allow the Fed to continue raising rates into 2019. With higher yields from rising rates, we recommend investors focus on short-term fixed income opportunities. 2018 Wells Fargo Investment Institute. All rights reserved. Page 4 of 6
Economic Calendar Date Country Report Estimate Previous 12/18/2018 GERMANY IFO Business Climate 101.6 102 12/18/2018 BRAZIL CNI Consumer Confidence -- 113.6 12/18/2018 JAPAN Exports YoY 1.10% 8.20% 12/18/2018 US Housing Starts -- -- 12/18/2018 US Building Permits -- -- 12/18/2018 US Housing Starts MoM -- -- 12/19/2018 UK CPI YoY 2.30% 2.40% 12/19/2018 JAPAN All Industry Activity Index MoM 2.00% -0.90% 12/19/2018 US FOMC Rate Decision (Upper Bound) 2.50% 2.25% 12/19/2018 US MBA Mortgage Applications -- -- 12/19/2018 US Existing Home Sales -- -- 12/19/2018 US Current Account Balance -- -$101.5b 12/19/2018 US Existing Home Sales MoM -- -- 12/20/2018 UK Bank of England Bank Rate 0.75% 0.75% 12/20/2018 JAPAN Natl CPI Ex Fresh Food YoY 1.00% 1.00% 12/20/2018 US Initial Jobless Claims -- -- 12/20/2018 US Leading Index -- -- 12/20/2018 US Philadelphia Fed Business Outlook -- 12.9 12/20/2018 US Continuing Claims -- -- 12/20/2018 US Bloomberg Consumer Comfort -- -- 12/20/2018 US Bloomberg Economic Expectations -- -- 12/21/2018 EUROZONE Consumer Confidence -4.3-3.9 12/21/2018 US GDP Annualized QoQ -- -- 12/21/2018 US U. of Mich. Sentiment -- -- 12/21/2018 US Durable Goods Orders -- -- 12/21/2018 US Personal Income -- -- 12/21/2018 US Personal Spending -- -- 12/21/2018 US GDP Price Index -- -- 12/21/2018 US Durables Ex Transportation -- -- 12/21/2018 US Personal Consumption -- -- 12/21/2018 US Core PCE QoQ -- -- 12/24/2018 MEXICO Unemployment Rate NSA -- 3.24% 12/24/2018 BRAZIL Trade Balance Weekly -- -- 12/24/2018 US Chicago Fed Nat Activity Index -- 0.24 Source: Bloomberg as of December 14, 2018. 2018 Wells Fargo Investment Institute. All rights reserved. Page 5 of 6
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