Citing some deterioration in leading indicators of credit performance for U.S. households, Moody’s Ratings is now expecting consumer loan delinquencies to rise over the next 12 months.
In a new report, the rating agency has downgraded its expectations for U.S. consumer credit performance in the face of higher inflation and signs of possible weakness in the labour market.
While consumer loan performance has held up well so far this year in the face of negative economic headwinds — such as the U.S.-Iran war and its impact on global oil prices — certain forward-looking indicators are signalling rising credit stress.
For instance, certain measures of unemployment and inflation-adjusted income “have weakened in recent months,” Moody’s noted.
“Overall job growth has slowed considerably over the past year, and jobs added have been fairly narrow, driven largely by lower-paying healthcare jobs,” it said — adding that a stagnant job market increases the risk of loan delinquencies.
The prospects for the job market are also complicated by the rapid adoption of AI — which Moody’s said hasn’t had a material impact on employment and labour productivity yet, but still “adds uncertainty and risk around these metrics.”
At the same time, stronger inflation has already driven a decline in real disposable income, on a year-over-year basis, it noted. This is pressuring household savings and raises the prospect of interest rate hikes that would also weigh on household credit performance.
Moody’s reported that the personal savings rate has now been below 5% for over a year, which is “often a harbinger of rising consumer delinquencies and charge-offs.”
At the lower-end of the income spectrum, the weakness in savings reflects the impact of inflation on household purchasing power, it noted. Meanwhile, for higher-income households, unrealized gains in stock markets are having a “wealth effect” that resulted in these households to spend more of their savings.
However, this kind of wealth effect driven spending can quickly dry up, Moody’s cautioned.
“Higher spending driven by unrealized gains on stocks erodes consumers’ savings buffers, and use of leverage can exacerbate the risks since such gains can evaporate quickly,” the report said. “Indeed, a key factor in the 2008 financial crisis was consumer spending based on the perceived wealth carried in homes, which ended up being worth much less.”
In the current climate, households’ mortgage costs are rising too, Moody’s noted, as the ultra-low rates that were available during the pandemic are disappearing.
The average monthly mortgage payment “has risen sharply following the pandemic-era refi boom, which should lead to weaker credit performance as mortgages with very low rates run off and are replaced by mortgages with higher rates and monthly payments,” Moody’s said.
And, loan underwriting standards, particularly for auto loans and credit cards, have eased over the past year, it noted — a development that will lead to higher delinquency rates in the months ahead too.