Does Credit Still Pose Risks to the US Economy?

Real GDP growth slowed in the first quarter of 2024, compared to the rapid expansion seen in the second half of 2023. The US economy is nevertheless still booming, as reflected by buoyant domestic demand, which climbed by an annualized 2.8% in the first quarter. This was partly due to quarterly growth in real spending on services, which was the strongest it's been since 2014 (except for upticks due to the end of lockdowns). Even April hiring, which was down slightly from previous months, isn't that much of a concern.

A number of factors explain the resilience of domestic demand and household consumption. One is rising salaries. The wealth effect—amplified by soaring stock indexes, higher interest income and rising home prices—has also boosted consumer spending. The substantial surplus savings consumers built up during the pandemic also allowed them to keep spending. But researchers at the San Francisco Fed External link. believe pandemic‑era savings have now been spent, leaving households with less of a cushion against economic uncertainty. They point out that "consumers could use debt—such as credit cards and personal loans—to further support their current spending habits, although the current elevated interest rate environment means that the cost of using credit is higher than in the decade preceding the pandemic recession."

Of course, credit could prove useful for consumers who want to spend more than they currently earn. The last few days have seen the release of fresh data on changes in consumer credit, as well as attitudes to credit on the part of financial institutions, households and businesses.

First, compared to 2022, consumer credit growth has significantly cooled since the fall of 2023 (graph 1). That's no surprise, as that's generally what happens when interest rates go up. Until February, the slowdown was most obvious in term loans. However, the monthly gain in revolving credit (cards and lines of credit) was particularly low in March. It remains to be seen whether this recent soft patch is just a passing phase or the sign of a lasting trend toward weaker growth.

A key factor in how the credit market develops over the coming months will obviously be the interest rate trajectory. The recent lack of progress on inflation should prompt caution among Federal Reserve (Fed) officials at their next few meetings. The upcoming elections will likely limit what the Fed can do, since it probably won't want to pivot on interest rates in the midst of the election campaign External link. unless it's absolutely necessary. We therefore don't expect the central bank to begin monetary easing until November. Higher‑for‑longer rates should keep a lid on credit in the US, and possibly here in Canada as well, External link. even though the Bank of Canada will likely start cutting rates soon.

Obviously, interest rate movements are key, but the willingness of financial institutions to extend credit is nevertheless an important factor. Once again, this week we got new information to chew on with the publication of the Fed's quarterly Senior Loan Officer Opinion Survey.

What stands out the most is that financial institutions haven't relaxed their credit conditions for most types of loans to individuals or businesses. But there's a smaller share of institutions that keep tightening their conditions (graph 2).

Institutions continue to see weak demand for credit (graph 3), which is to be expected as long as market interest rates remain high. At least the situation isn't getting worse.

That said, there are still quite a few risks. Late payments on credit cards and—to a lesser extent—car loans are mounting. The situation seems relatively under control for late payments on student loans and mortgages, while personal bankruptcies are currently at a historic low in the United States. A faltering job market and persistently higher unemployment could nevertheless worsen the situation.

Although this isn't our baseline scenario, sticky or even rising inflation that would force the Fed to start hiking rates again also poses major risk. This would drive market and retail rates back up. Until now, the economy has shown surprising resilience in the face of high rates. But a further tightening of financial conditions could be the straw that breaks the camel's back and triggers the downturn that the United States has managed to avoid. This could disrupt a soft landing.

These factors suggest that the credit trajectory isn't cause for major concern, at least for now. However, as long as interest rates stay relatively high, risks remain for the US economy.