Financial conditions for households and non-financial businesses in the United States continued to improve in the second quarter of 2021, as our Financial Frailty Index fell further below its historical average to its lowest level since the fourth quarter of 2010. The headline index fell to -2.12 in the second quarter. quarter of -1.53 in the first, with improvements in both sub-indices for households and businesses (see chart 1). Consistent 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 below its historical average of zero.
Financial conditions have remained sound over the past year and a half, at the cost of rapidly growing central bank balance sheets and higher public debt. That said, strong household and corporate balance sheets should pave the way for further expansion of the U.S. economy, despite ongoing supply chain bottlenecks, tighter monetary policy and uncertainty over the variant of the omicron coronavirus. The risk of recession over the next 12 months is 10% to 15%, the lowest in almost seven years.
Households: Debt has fallen amid stable liquidity and wealth
For households, lower debt risk amid stable liquidity risk and wealth effects is likely what brought the financial fragility index down to -2.47 from -1.98. (see graph 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 taken off the books) was the main reason for which the risk of indebtedness has decreased.
However, the debt service ratio and the debt-to-income ratio rose faster as personal income fell slightly, while consumer credit rose in the second quarter, reversing some of the improvements in conditions of indebtedness. Liquidity and wealth effect indicators remained stable.
Non-financial companies: liquidity conditions have improved while leverage risks have increased
For companies, the financial fragility index also fell to -1.77 in the second quarter from -1.07 in the first, its lowest level since the fourth quarter of 2010, as liquidity risks diminished considerably while risks of indebtedness increased slightly (see chart 3). Specifically, the short-term asset-to-debt ratio rose faster year-over-year in the second quarter, further mitigating liquidity risks. At the same time, the interest rate coverage ratio increased at a slightly lower pace (but still high compared to the historical average), with leverage risks increasing slightly.
The index is a weighted average of indicators that reflect the financial fragility of companies and households from different angles. We use principal component analysis to construct the index. The index not only includes current indicators, but also their recent history to account for the possibility that financial risk may take time to mature and affect the economy. Zero represents the sector’s financial vulnerability at historical average levels; positive values indicate higher vulnerability to history. For more information on our methodology for constructing the Financial Fragility Index, see “Economic Research: The Financial Fragility Of US Households And Businesses Hit A Decade Low In The First Quarter”, published July 30, 2021.
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