The Federal Reserve began tightening mon-etary policy in March 2022 to combat higher inflation. This tighten-ing, in turn, increased borrowing costs for a wide range of consum-er financial products such as auto loans, mortgages, and credit cards. Higher borrow-ing costs can dampen demand as households use more disposable income to service inter-est expenses, which, in turn, can cool inflation. Despite the large, sustained increase in interest rates over the last couple of years, consumer finances borrowers since policy tightening began. Although delinquency rates have risen for subprime borrowers by 5.6 percentage points over the same period, these borrowers make up only 23% of the total consumer credit market.
Delinquency rates are indeed a critical tool for assessing the financial health of households and banks, but the underlying payment behavior of credit card users may provide additional information.
Revolving balances, for example, measure the percentage of credit card balances that are rolled into the following pay period and thus carry interest. Higher revolving balances indicate increased stress and can be a harbinger for future delinquency. Revolving balances for both prime and subprime borrowers remain below their pre-pandemic levels.
Stable revolving balances suggest households are not rolling over additional credit card debt and are thus better able to pay off balances.
In addition, internal bank assessments suggest that the probability of default among subprime borrowers remains at historically low levels, despite the increase in delinquency rates. Bank forecasts for subprime default have remained stable since the first quarter of 2023, suggesting banks see few signs of credit deterioration and charge-offs that would eat into their earnings and capital.
Moreover, subprime delinquency rates may stabilize soon. Bank default forecasts can be a useful indicator for future delinquencies. For example, when subprime default forecasts fell sharply in 2020, delinquencies followed suit, albeit at a lag of approximately 12 to 18 months. Given that subprime default forecasts plateaued in early 2023, the trend suggests that subprime delinquency rates could stabilize in the coming quarters as well.
On balance, consumer credit markets show limited evidence of mounting stress, even among subprime borrowers. Although subprime delinquencies have increased, rollover behavior and bank forecasts for these borrowers do not indicate a major deterioration in credit quality. Moreover, the recent easing in monetary policy may limit further deterioration in this market.
Jordan Pandolfo is an economist at the Federal Reserve Bank of Kansas City. He joined the Economic Research Department in 2023.