The US Federal Reserve (Fed) raised interest rates again in June, arriving at many economists call a neutral policy rate. Calculated in different ways, the neutral policy rate basically means the Fed is neither stimulating the economy nor restraining it. This change marks an end to the post-crisis decade of accommodating monetary policy, where the Fed sought to boost economic activity through ultra-low interest rates and massive asset purchases, known as quantitative easing.
However, Fed Chair Jerome Powell again suggested the central bank expects to raise interest rates further this year and next. As rates rise, the cost of repaying many loans goes up for both business and consumers. Higher interest rates may raise the interest portion of mortgage and credit card payments.
Higher interest, but stronger consumers
As interest costs for US households increase, it is still unlikely to put a major burden on US consumers. There are three main reasons to have confidence in US consumers repayment ability.
Households are financially fit. Unemployment is at the lowest level in this century, and the median projections for unemployment through 2020 were lowered to 3.5%. Meanwhile, wage growth in May stayed above 3% for the third month in a row, showing wages may be beginning to rise as employers compete for fewer workers.
- The US economy is growing. US GDP growth topped 4% in Q2, and the Fed raised its full-year projection to 2.8% from 2.7% for 2018 economic growth. Meanwhile, the Fed’s preferred inflation measure, personal consumption expenses (PCE), is rising. The Fed expects PCE to reach 2.1 % in 2018 and 2019, quite close to its target of 2%.
- The Fed sounds confident. Since the global financial crisis, the Fed has worked hard to craft its statements so as not to surprise market participants. As a result, it is not accidental that the statement produced at the June meeting upgraded the assessment of economic growth from “moderate” to rising at a solid rate”. Similar optimistic upgrades in the way the statement discussed unemployment and household spending show the Fed is more confident.
What does this mean for consumer credit assets?
The repayment ability of the consumers depends highly on the employment condition and their ability for consumption depends on their confidence with the employment circumstance and the expectation of wage growth.
US consumers are likely to continue to have a strong repayment ability for the foreseeable future, despite higher interest rates. As unemployment stays low and economic growth remains stronger than the 2.5% growth rate for advanced economies, according to the IMF.
All this means the window for investing in consumer credit assets is still wide open as any potential repayment issues are far off. The deterioration in the US labor market, as well as a downturn in the US economy, are slow-moving factors and they do not happen overnight. Investment managers in consumer credit will have a long lead time to adjust their investment strategy accordingly instead of suffering an overnight impact.
As an experienced consumer credit investor, FinEX Asia combines decades of investment management experience and consumer risk expertise with a best-in-class technology platform that has helped the asset under management to achieve industry-leading returns.
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