With the moratorium on federal student loans ending soon, discretionary spending is likely to go down and delinquency is likely to rise as consumers face the end of a three-year reprieve.

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Welcome to Thoughts on the Market. I'm Sarah Wolfe from the U.S. Economics Team. Along with my colleagues, bringing you a variety of perspectives, today I'll be talking about the implications from the upcoming student loan restart. It's Tuesday, July 18th at 10 a.m. in New York.

The more than three year long moratorium on federal student loans is ending soon, expected to resume on October 1st, impacting nearly 27 million borrowers who have federal student loans in forbearance, totaling a trillion dollars or $41,000 per borrower on average.

We believe this will translate into a hit to disposable income and a moderate pullback in discretionary spending in the fourth quarter of this year and partially into the first quarter of 2024. Altogether, we estimate it could shave about ten basis points off of total year real PCE growth or seven basis points off GDP growth. But we think that this is likely an upper estimate for a few reasons. First of all, there's a 12 month grace period that will allow households to take the next year to start making payments without falling delinquent—so not everybody is going to start making payments in October—consumers can tap into their savings and there could be debt reprioritization.

There's going to be varying impact across different demographics. We find that those aged 25 to 34 are most likely to hold student debt, But borrowers age 35 and older hold the largest debt balance in dollar terms and as a share of disposable income. We also find, based on geography, that southern states, including Mississippi, Alabama, Georgia and South Carolina, have the highest average student loan balance as a share of per capita disposable income while states in the Northeast, like Massachusetts, Connecticut, New Jersey and New Hampshire have the lowest. It's worth mentioning that this is more of a result of disposable income being lower in southern states than debt balances being higher.

So how will this impact credit? My colleagues from the Morgan Stanley U.S. consumer finance team expect the combination of student loan payments starting in October with the absence of loan forgiveness to lead to potential delinquencies as consumers divert cash flow, servicing other forms of debt like credit card and autos, towards their student loans. This could accelerate delinquency rates which are now above 2019 levels and increasing at the fastest clip in 15 years.

One thing we're keeping an eye on are the new Biden administration initiatives that could provide some relief for low and middle income consumers. For example, as I mentioned, a 12-month ramp up grace period for borrowers means they won't be penalized or moved into delinquency if they fail to pay over the next year, though interest does still accrue. Also, a new save income driven repayment option should fully go into effect as of July 2024, lowering payments owed by undergraduate borrowers if they adopt this new income driven repayment plan.

Overall, we believe the student loan repayment restart will be a hit to spending and borrowing that will spill over into U.S. hard lines, so these are appliances and sports equipment, broad lines, which are companies that deal in high volume at the cheaper end of a product line, and food retail industries, though at varying degrees. Retailers with customer demographics skewed towards younger and lower income consumers that sell into more discretionary categories appear to be the most at risk.

Furthermore, our soft lines retail—that is clothing—and brands team think companies with outsized exposure to luxury and men's apparel, denim and swim could see the biggest slump in demand from student loan repayment, whereas those with sports apparel and footwear exposure may be the most insulated.

That said, the bottom line is that no retailer is free from exposure to all three key student loan holder demographics, which skew younger, less affluent and more urban.

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