Rates, Spending, & Borrowing: A High-Level Outlook

Over the past few months we’ve reflected on the many financial battles facing consumers, and how your credit union might respond. Last October, we reviewed the Federal Reserve’s continued fight against inflation using accelerated interest rate hikes. In December, we analyzed the broader state of the housing market. From there, we explored consumer credit and the future borrowing base. In this article, we’ll take a high-level look at those same issues with an aim towards helping you update your strategic focus for the months ahead.

What’s the outlook for interest rates and inflation?

As of June 2023, inflation is hovering around 4.0% The last time inflation rates hovered around 4.0% came nearly two years ago in May of 2021. In the time in between, inflation has tracked much higher forcing consumers to deal with escalating prices for goods and services for an extended period of time.

Since 2022, the Federal Reserve, in order to combat higher inflation, has been increasing the Federal Funds Rate. As of June 2023, the effective federal funds rate is at 5.25% – a 500 basis point increase since the start of the campaign. Consumers have thus been forced to also deal with escalating credit costs for an extended period of time.

Where are rates headed? Per Fed Chairman Jerome Powell last month, the Fed “may not be far off, or possibly even at,” the level to which it may not have to continue to raise rates. However, the Federal Reserve’s inflation target is 2%, meaning inflation is still too high. Given the commentrary and the target, it is likely that rates stay at their present level for quite some time, and if they are increased in any capacity, it might be done minimally – to the tune of 25 basis points – if trends continue.

What’s the outlook on consumer spending?

Despite high inflation, high interest rates, and widespread economic uncertainty consumers are still mostly continuing to spend. Consider the chart below showcasing personal consumption expenditures. The data for this chart selection originates in 2018 to show pre- and post-COVID consumer behavior.

It’s clear that consumers are still incredibly active in terms of spending. That said, the state of consumer spending gets a little more confusing on a granular level. For illustrative purposes, consider these two headlines of articles that were published on June 6, 2023. First, “Cracker Barrel says it’s not alone in seeing a ‘meaningful’ traffic drop-off.” Second, “Royal Caribbean expects strong demand trends to continue through 2024, 2025.” Consumers are sending mixed signals despite broader concerns about the economy at large. Understanding where consumers are putting their dollars remains important, as it’s a worthwhile endeavor to meet consumers where they are – within reason.

This situation draws us back to a point we made in our article on consumer credit, when we discussed how credit unions should respond given rising delinquencies and charge offs, escalating debt levels (as a product of continued spend, a lot of which has to do with significant non-housing debt balances), and persistent costs of living increases. To reiterate, credit unions would be wise to (1) remember the importance of member education and guidance regarding the management of credit in the face of continued spending, and (2) maintain a heightened focus on risk mitigation.

Managing risk and providing educational opportunities will allow credit unions both protect themselves and encourage healthy member behaviors no matter which direction spending trends going forward. But do keep this in mind: if economic uncertainty were to increase, personal consumption would inherently begin to pull back and savings would begin to increase, according to basic economics.

What’s the outlook on mortgage lending?

In December’s article on “Planning Your Mortgage Strategy,” we noted the turmoil in the housing market. Now, six months later, there continues to be turmoil, with affordability of homes still out of the reach of many. Consider the chart below showcasing the average single family home price in the United States. Despite a brief pullback in January 2023, prices continue to rise.

Home affordability is further complicated by high mortgage rates. The chart below shows the current state of the 30-year mortgage rate.

United States 30-Year Mortgage Rate (Percent)

It’s appropriate to re-ask a question that we posed in that December article. Given how high the rates and prices are, why might someone buy a house? The short answer is that many won’t – and haven’t been. This is observable in the below chart on existing home sales.

United States Existing Home Sales (Thousands)

But despite the many challenges to first mortgage lending, the current market does present opportunities by way of home equity lending. Home equity loans and lines of credit allow homeowners to tap into their home equity (market value less mortgage balance), which opens doors for individuals and families to pay off debt, cover cost of repairs or renovations, or even pay for other obligations – while using the house as collateral.

According to TransUnion, demand for home equity lines of credit has surged, with full 2022 data showing the most home equity loan originations on record since 2010. This is significant because the increase in home equity lending is continuing to parallel the decrease in the number of home sales in the United States.

That said, tapping home equity is not exactly a low-cost source of funds given high rates (and the possibility of even higher rates on variable rate home equity credit lines). There’s also the possibility of home equity values falling and resulting in negative equity should we see an economic downturn. It is wise, therefore, to pay attention to consumer behavior, where money is being spent, and to actively manage your equity lending policies accordingly. You’ll also want to maintain an abundance of home lending education resources to teach members proper use and management of equity loans.

The View from Above

It’s difficult to gauge the exact direction of the economy given the nature of consumer spending, continued high inflation and interest rates, and the changing home lending market. It’s important therefore to look at the underlying actions of consumers and consider whether or not to align credit union strategy to meet demand.

Principally, consumers are continuing to spend. Personal consumption expenditures keep increasing despite the changes to consumers’ granular decisions on where specifically money is being spent. Increased spending coincides with broader increases in non-housing debt, which has been a continued trend since we discussed the topic in our late March article. It’s also notable that the demand for home equity lines of credit keeps increasing, which gives valuable insight into the state of the housing market, with individuals and families opting to stay put instead of move.

So where can you continue to meet the needs of your members? Let’s consider a few ways:

• Make adjustments to your strategic involvement in the housing market and mortgage business so that you are offering what members want.
• Make the most of the improved interest margins, reinvesting in product development or in strategic pricing advantages that benefit members.
• Update your educational opportunities to help members make informed financial decisions given today’s marketplace dynamics and preferred lending products.

The Strategic Planning Process

Your strategic plan should be where you turn for guidance on how to respond to the kinds of marketplace dynamics we outlined above. If your plan, or your process, needs a lift, we can help. Our strategy planning process factors in your internal business model, and your external environmental and competitor influences – including the kinds of economic issues outlined above. Learn more, or follow the Contact Us link below.

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Photo by ian dooley on Unsplash