U.S. private sector debt declines, increasing recession risks

U.S. household and corporate finances are strong, but a trend of reducing debt could lead to problems for the economy. Recent data from the Federal Reserve shows families and businesses had a high asset wealth and low debt at the end of 2024. However, when excluding the growing federal government debt, there is a worrying trend emerging. Morgan Stanley reports that private sector debt dropped by 2.4% of gross domestic product (GDP) in the last quarter of 2024. This is the biggest decrease since the financial crisis in 2008. Both households and non-financial businesses, as well as government entities, decreased their debt for the first time ever in the same quarter. This decline may be linked to uncertainty surrounding the U.S. elections and Donald Trump's potential return to office. Early 2025 does not show much improvement, with ongoing trade tensions and market volatility adding to concerns. Experts warn that continued reductions in private sector debt could harm the U.S. economy, as this behavior is not typical for a healthy economy. Some analysts predict the Federal Reserve may be ready to ease up on monetary policy more than expected. They believe a recession within the next year could be as high as 40%. The market's assumption that a decline in stock prices would prompt the government to change course may not hold true. Despite the tough conditions, the stock market seems eager to rally as the first quarter closes. Many investors still hope for government support, but two major issues loom. First, equity and corporate debt markets have not fully accounted for the risk of a recession. Second, there is a possibility that the expected government support may not happen at all.