Consumer Credit at All-Time High: What Does This Mean for the Fed Chair Race?

Consumer credit as a percent of disposable income is at an all-time high. What could the policies of John Taylor and Jerome Powell mean for consumers?

Americans have been tapping into credit at levels we’ve never seen before. Some of the faster growing types of credit, like credit cards and student loans, float with interest rates. This means that more Federal Reserve rate hikes could make it harder for households to pay off debt. However, we might not see a wave of defaults that we’d expect in these circumstances.

That’s according to Wells Fargo’s Chief Economist John Sivlia and analyst Harry Pershing. In a weekly interest rate research note released on October 25th (link here), Silvia and Pershing note that consumer credit is at an all-time high compared to disposable income. That would normally bring about fears of a coming crisis, as a wave of defaults could push the U.S. economy right back into recession.

However, the authors argue that the Fed will raise interest rates slower than incomes will rise. That would mean consumers would pay more on debt, but it would be less of a burden compared to incomes.

Household debt delinquencies have mostly been falling since the Financial Crisis of 2008-09. Even though consumers are taking on more debt as a percent of income, they are still paying it down and not defaulting. Steady economic growth and a continuously improving labor market are certainly making consumers feel better about their debt burdens. The only way we’d see a spike in defaults is if rates rise much faster than expected.

What does this mean for the Federal Reserve Chair race?

Jerome Powell and John Taylor are the front-runners at this point. Powell would represent a continuation of current Fed policy, while Taylor is a bit more of a wild card.

Taylor’s famous Taylor Rule formulates the proper level of Fed base interest rates. It currently stands at about 3.0 percent. This is sharply higher than the current level of 1.25 percent. A move this big would be a huge shock to consumers holding floating rate debt.

Not everyone is convinced a Taylor Fed would raise interest rates this much, though. Taylor recently argued that the economy could withstand a 3 percent growth rate without too much inflation (specifically, if tax cuts lead to GDP growth). That would be a reason to leave rates lower.

Yellen, on the other hand, thinks inflation will tick upward if a massive tax package is passed. She would likely opt to raise rates in this scenario. Countering prevailing opinion, rates could be higher in a Yellen/Powell Fed than a Taylor Fed.

Consumers have benefited from a steady and predictable economy over the past decade. A massive shift in monetary policy could be the trigger that upends this consumer confidence, which makes this Fed horse race so intriguing.

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