Key Takeaways
- Our financial fragility index for U.S. households and firms fell to -2.12 in the second quarter from -1.53 in the first, indicating that financial conditions continued to improve.
- Our household financial fragility index, its lowest on record, is largely explained by lower leverage risk amid stable liquidity risk and wealth effects, which brought the financial fragility index down.
- For firms, liquidity risks declined substantially, though leverage risks edged up.
- Households' and firms' strong balance sheets should set the stage for further expansion of the U.S. economy in 2022, helping to offset headwinds from supply chain disruptions, tighter Fed policy, and the omicron variant. Recession risk over the next 12 months is 10% to 15%, the lowest in almost seven years.
The financial conditions of U.S. households and nonfinancial corporates kept improving in the second quarter of 2021, as our financial fragility index dropped further below its historical average to the lowest level since the fourth quarter of 2010. The overall index dropped to -2.12 in the second quarter from -1.53 in the first, with improvements in both subindexes for households and firms (see chart 1). In line with our findings, the Chicago Fed's National Financial Conditions Index also improved to -0.71 in the second quarter from -0.63 in the first and is lower than its historical average of zero.
Financial conditions have stayed healthy over the last year and a half, at the cost of rapidly growing central bank balance sheets and higher public debt. That said, households' and firms' strong balance sheets should set the stage for further expansion of the U.S. economy, despite continued supply chain bottlenecks, tighter monetary policy, and uncertainty about the omicron coronavirus variant. Recession risk over the next 12 months is 10% to 15%, the lowest in almost seven years.
Chart 1
Households: Leverage Dropped Amid Stable Liquidity And Wealth Conditions
For households, lower leverage risk amid stable liquidity risk and wealth effects are likely what brought the financial fragility index down to -2.47 from -1.98. (see chart 2). This is the lowest reading since the first quarter of 1987. Lower year-over-year growth in charge-off rates (the value of loans and leases removed from the books) was the main reason leverage risk declined.
However, the debt-service ratio and debt-to-income ratio grew faster as personal income edged down, while consumer credit grew in the second quarter, offsetting some of the improvements in leverage conditions. Both liquidity and wealth effect indicators remained stable.
Chart 2
Nonfinancial Corporates: Liquidity Conditions Improved While Leverage Risks Rose
For firms, the financial fragility index also declined to -1.77 in the second quarter from -1.07 in the first, its lowest since fourth-quarter 2010, with liquidity risks declining substantially while leverage risks edged up (see chart 3). Specifically, the ratio of assets to short-term debt grew faster on a year-over-year basis in second quarter, further alleviating liquidity risks. Meanwhile, the interest rate coverage ratio grew at a slightly lower rate (but still high compared with the historical average), with leverage risks rising a bit.
Chart 3
The index is a weighted average of indicators that reflect the financial fragility of corporates and households from different perspectives. We use principal component analysis to construct the index. The index includes not only the indicators at present but also their recent history to account for the possibility that financial risk may take time to mature and affect the economy. Zero represents sector financial vulnerability at historical average levels; positive values indicate higher vulnerability compared with history. For more information on our methodology for constructing the financial fragility index, see "Economic Research: The Financial Fragility Of U.S. Households And Businesses Hit A Decade Low In The First Quarter," published July 30, 2021.
The views expressed here are the independent opinions of S&P Global Ratings' economics group, which is separate from but provides forecasts and other input to S&P Global Ratings' analysts. S&P Global Ratings' analysts use these views in determining and assigning credit ratings in ratings committees, which exercise analytical judgment in accordance with S&P Global Ratings' publicly available methodologies.
This report does not constitute a rating action.
| U.S. Chief Economist: | Beth Ann Bovino, New York + 1 (212) 438 1652; bethann.bovino@spglobal.com |
| Contributor: | Shuyang Wu, Beijing |
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