From the latest BCA Bulletin:
Investors remain fearful that a sizable consumer retrenchment
looms. While consumers will contribute less to economic growth
than in the past few years, spending is likely to be solid even in the
face of rising interest rates. Income growth is already fairly strong
and will improve further with employment recovering. Rising inter-est
rates will become a progressive drag, but probably less than is
widely feared, at least initially (for more on this topic, clients are
referred to our recent Special Report 1 ). The top panel on Chart 7
on page 8 shows that the growth rate in disposable income before
and after subtracting debt service payments is virtually identical,
underscoring that debt servicing is not a major factor in consumer
spending patterns. Based on an interest rate increase of 300 bp at
the short end of the yield curve and 100 bp at the long end over
the next 18 months, consumer interest payments should only move
in line with past Fed tightening cycles (second panel, Chart 7 on
page 8), i.e. no worse than in the past. Contrary to what one
would expect, there is no evidence that consumers have become
more sensitive to changes in borrowing rates, despite the persis-tent
rise in debt-to-income ratios since WWII.
Table 1 (I attempted to line it up below - MK) shows a simple calculation of the increase in consumer interest
expense for a 100 bp rise in borrowing rates. As a share of disposable
income, the rise in interest payments is roughly the same
today as it would have been 10 and 20 years ago, even though
debt levels are significantly higher! This surprising result is partly
explained by the marked increase in fixed-rate debt (i.e. consumers
have been borrowing more at the long end of the curve). Mortgages
make up a greater portion of total consumer debt and fixed-rate
mortgages are now a larger percentage of total mortgage debt
. These developments insulate borrowers
from the initial phase of rising interest rates. Thus, consumers
should prove resilient until later in the rate cycle, especially in light
of improving employment conditions and solid wage growth.
Consumer
Debt/Income
Ratio
Fixed Rate Debt
as a % of Total
Consumer Debt*
Change in Interest
Expense for a 100 basis
Point Increase in Rates**
(% of Income)
1985 59.2% 64.9% 0.21%
1995 78.8% 67.8% 0.25%
2004 103.0% 78.1% 0.23%
* Fixed rate debt is defined as total mortgage debt (excluding adjustable rate
mortgages) plus non-revolving consumer loans.
** Assumes no change in interest expense on fixed rate portion of debt. |
