How Consumers Influence Interest Rates

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Industry Outlook, Rob Chrisman's Perspectives

According to many economists, consumers are prepared for rising interest rates. This statement is backed by examining, not only consumption behaviors, but the willingness of consumers to place certain debt obligations on their household balance sheets. Last year’s numbers don’t lie. According to the Federal Reserve, in 2015, household net worth increased in the fourth quarter, offsetting the decline in Q3 and reaching another all-time high of $86.8 Trillion. Assets rose by $1.7 Trillion in the quarter while liabilities posted a slight increase, resulting in a bounce of household net worth. The 1.9% jump in fourth quarter net worth pushed YoY gain to 3.1%. Looking at household assets, specifically nonfinancial assets which include real estate and any wealth held in precious metals, these assets have been the fastest growing component over the past years showing an increase of 6.1% This growing number is, largely driven by real estate which has increased by 6.6%. Compared to financial assets (stocks bonds, etc) which have grown at a slower rate, with households’ holdings of equities and corporate bonds falling over the last twelve months. As many people in mortgage banking can tell you, over the last few years, consumers have become more willing to assume the challenges of buying homes. According to one industry report, credit loans and mortgages have accounted for the majority of the increase in household liabilities over the past year. This helped push total loans up 2.5% YoY.

Fortunately, this brings us to the household Debt-Service Ratio (DSR). The DSR is the Federal Reserve’s ratio of total required household debt payments to total disposable income. The DSR is divided into two parts. The Mortgage DSR is total quarterly required mortgage payments divided by total quarterly disposable personal income. The Consumer DSR is total quarterly scheduled consumer debt payments divided by total quarterly disposable personal income. The Mortgage DSR and the Consumer DSR sum to the DSR. I was confused too, until I realized this was just an expanded DTI ratio. The household debt-service ratio remains near all-time lows at 10.1%. This relatively low number is a reflection of consumers “deleveraging” in the household sector (r/t refinances, selling 2nd homes), coupled with, and a reflection of, record low interest rates. In the US, around 83% of mortgage debt is tied up in fixed rate mortgages, so most homeowners have hedged against future rate rises for the duration of their loans. On the flip-side, the minority of mortgage holders with ARMs will be the ones exposed to a rate hike. Assuming this is the case, many analysts believe that mortgage interest payments will be around $60 billion higher by 2020. This equates to less than 0.5% of current US GDP. At a macro-level, and assuming real wages continue to grow, aggregate household disposable income will remain relatively unaffected by tighter monetary policy.

While consumers have been lowering their debt in one area (housing expense) over the last few years, they’ve been raising it in another. Consumer credit has been one sector where households have increased their borrowing. Non-revolving credit has grown rapidly since 2008/2009, as consumers take advantage of low rates and easier lending standards. From 2011 to 2015 consumer credit liabilities have increased from $2.7 Trillion to $3.5 Trillion. While the pace of lending growth in consumer credit will likely slow, when coupled with an acceleration in mortgage lending and the ever present forecast for higher interest rates, the result is a higher economy-wide debt-service ratio. That said, the current low level means (to some) that consumers are not overly sensitive to higher rates, and hence, have forecasted modest increases in long-term rates which should not derail economic growth in 2017.