submitted by
Uric Dufrene, Ph.D., Interim Executive Vice Chancellor for Academic Affairs, Sanders Chair in Business, Indiana University Southeast
One of the reasons why we have not seen a recession this year, and likely for the rest of the year, has to do with the consumer, driver of almost 70% of the U.S. economy. So, what is happening with the consumer will often provide clues about the direction of the U.S. economy. Last year, for example, the economy was seeing 40-year high rates of inflation. Skyrocketing inflation was expected to break the backs of the consumer, and a recession would then follow. Additionally, consumer sentiment was in the doldrums, not only due to higher prices but also the collapse in both stock and bond values. Stock market indices saw significant erosion, and bond values declined due to increasing interest rates. Consumer conditions were not favorable, and a recession was almost certain, as also evidenced by an inverted yield curve (short-term bond yields are higher than long-term bond yields), a reliable predictor of past recessions.
Despite challenges, consumers have held up, steering the economy clear of a recession, at least for this year. Consumer spending on services has not slowed down. It took almost two years to recover from the decline in spending due to Covid, but spending has been increasing since. Goods spending saw astronomical gains coming out of Covid but has been normalizing since. Goods spending peaked in April 2021, and has decelerated since, but that was to be expected. Households can only make so many home repairs and buy so many couches, refrigerators, and RVs!
Higher mortgage rates were expected to also thwart the consumer, but most households with mortgage balances had already locked in an ultralow mortgage rate, immune from subsequent rate increases. Most are not eager to replace a low-rate mortgage with a higher rate, and this is one of the reasons why the housing supply, or homes available for sale, continues to be challenged. Existing home sales, at the national level, are down more than 30% from a year ago. Higher mortgage rates have impacted some industries, like real estate, housing, and mortgage finance, but the impact on most consumers has been minimized.
One of the contrary benefits of higher mortgage rates is the impact on supply. Restricting supply is providing support to home prices, when normally, higher mortgage rates might adversely impact housing values, like the housing crash that ultimately brought about the Great Recession of 2007. Strong home values are providing a boost to homeowner’s equity, building wealth, and supporting a resilient consumer. Since the Great Recession, home equity loans have been on a continued downward slope, but since last year, home equity loans rebounded, allowing homeowners to tap into this wealth to support consumer spending.
This added equity to the household balance sheet is also giving consumers the confidence to take on more debt. Consumer debt dipped coming out of the Covid recession but started climbing around mid-2021. Debt continues to increase, but the rate of growth has subsided. Household debt ratios had dropped to a 30-year low in March 2021 and began climbing to a pre-pandemic high in late 2022. Since then, household debt ratios have declined slightly, providing more ammunition for subsequent consumer spending. A red flag is beginning to emerge on the consumer debt side, however. While delinquency rates are lower than pre-pandemic levels, and significantly below rates associated with the Great Recession, delinquency rates on consumer loans and credit cards have been climbing.
Household checkable deposits have declined from a peak in September 2022, but remain considerably higher than pre-pandemic levels. Consumer sentiment continues to climb from the trough of June 2022 but is at levels that historically coincide with recessions. Inflation continues to moderate, and the last report showed a decline in the core rate, previously referred to as “sticky”. The progress made on inflation is supporting consumer sentiment, one of the reasons why sentiment has been trending upward. The labor market has softened a little but is still very tight. Job openings continue to exceed the number of unemployment and the growth in earnings now exceeds the rate of inflation. We are still expecting a slowdown in the economy, but the overall shape of the consumer is one of the reasons any economic contraction will be mild.
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