Household wealth accelerated on the downside in 2Q due to the downturn of the markets, but remains very high. Neither households, nor businesses, present imbalances in terms of debt.
The data on financial flows gathered by the Federal Reserve (Financial Accounts) in 2Q outline a sharp contraction in the wealth of households tied to the downturn of the markets. While this marginally strips consumer spending of support, it is also true that wealth remains at very high levels, after accelerating over the pandemic period.
Household debt is increasing, but remains at contained levels in relation to disposable income, and is therefore no cause for particular concern.
Businesses are also free of financial; balance sheets are solid, and for the time being no excesses or potential sources of volatility such as those seen during the Internet and real estate bubbles are on the horizon.
This will be of help in a phase in which downside risks to US growth are mounting as a result of the global slowdown and of the Fed’s actions, aimed at slowing demand to counter excessively high inflation.
Household wealth dropping sharply, but still high
In 2Q, the net worth (assets - liabilities) of households contracted by a record -6.1 trillion US dollars (-4.1%), after dropping modestly in 1Q (by -147 billion dollars). The exceptional increase recorded over the pandemic period, however, is keeping wealth at levels closer to the record-high marked at the end of 2021, than to those recorded at the onset of the pandemic (higher wealth than the levels recorded 4Q 2019 by a hefty 27 trillion dollars).
The drop is explained exclusively by the contraction of financial wealth. Vice versa, the value of property (that accounts for 28% of overall wealth) has grown further, whereas deposits held by households decreased from the peak hit at the beginning of the year, but moderately so, staying well above pre-Covid levels (earned income is balancing the termination of pandemic subsidies).
From the lows hit in mid-June, the stock markets are recovering modestly, while the bond markets are still on the decline. In the present quarter, the contribution made by financial wealth should therefore be more contained. However, the support offered by the property market should wane.
On the liabilities side, debt rose further: in 2021, growth had been driven by mortgages, whereas in 2022 consumer credit accelerated, at its fastest pace since 2001 in 2Q. Inflation affected the lower-income households, prompting them to take out consumer credit to support their spending (a behaviour put at risk by the increase of interest rates).
The overall level of debt, however, is no reason for concern at the present stage: in relation to disposable income, it has remained roughly stable at the previous quarter’s levels, i.e. just above pre-Covid levels (in line with 2017 values).
Debt/GDP: still on the decline
The growth of overall debt in the US slowed in the quarter (6.7% q/q ann. from 8%). Total debt in relation to nominal GDP dropped to 348%, but is 22 percentage points higher than it was in the pre-pandemic period. Debt growth in the quarter was driven by businesses (7.7%) and households (7.4%), whereas the pace of growth of Federal Government debt (5.6%) roughly halved compared to the previous two quarters.
In relation to GDP, Federal Government debt dropped slightly in the quarter, but is essentially stabilising at the high levels recorded over the past year.
The ratio of marketable Treasuries and GDP is falling gradually, to 94%, to below the 102% peak marked during the pandemic, but still well above pre-Covid levels (by 77%). The CBO’s estimates point to a marked reduction of the public finance deficit this year, from -12.4% in 2021 to -3.9% (and a further decline to -3.7% in 2023), as a result of higher revenues and smaller expenditure due to the expiration of the stimulus measures introduced to counter the pandemic.
Reduced issuance needs compared to 2021 is of help in preventing an excess supply of Treasuries in a phase in which the Fed is tapering its purchases, bringing into full swing QT in September, and forecasting fewer asset repurchases by 95 billion dollars per month (of which 60 billion in Treasuries).
Businesses: debt and investment
The debt of businesses resumed growing at a sustained pace in the opening two quarters of 2022. Financial leverage (ratio of debt and earnings) however, is essentially stabilising (and on the decline in the quarter) at below-trend levels and, lower than in the pre-pandemic period as well, due to the surge in earnings over the past quarters.
The absence of evident financial imbalances on the debt front is a factor of reassurance. However, higher cost of debt, after two years of extremely low rates, represents a drag on corporate investment.
Businesses sharply stepped up investment, thanks to low rates and to accelerating earnings. Earnings growth has now slowed and margins for self-financing (making investments using exclusively own means) are decreasing.
Going forward, recourse to external financing, at higher rates, represents will hold back investment growth.
Stock markets: valuation excesses reabsorbed
The decline of the stock markets from the peak hit at the beginning of the year, combined with the ongoing increase in profits, has pushed down sharply company valuations, now back in line with pre-Covid levels.
A measure of valuation such as Tobin’s Q, a ratio of the market value of firm and its net worth (total assets - liabilities), while staying at higher than average levels, has fully pulled back from the excessive levels reached following the onset of the pandemic, sending a message consistent with more punctual bottom up metrics, such as the price/earnings ratio (PE).
No longer excessive valuations represent useful protection for the markets against the risk of earnings “cuts”, as they already price in the slowdown of the economic cycle to a certain extent.