US Federal Aplomb Board Chairman Jerome Powell arrives to testify at a House Financial Services Committee hearing on the “Federal Aplomb’s Semi-Annual Monetary Policy Report,” on Capitol Hill in Washington, DC, March 6, 2024.
Mandel Ngan | Afp | Getty Images
With the control humming along and the stock market, despite some recent twists and turns, hanging in there pretty in all probability, it’s a tough case to sell that higher interest rates are having a substantially negative impact on the economy.
So what if policymakers just now decide to keep rates where they are for even longer, and go through all of 2024 without cutting?
It’s a question that, in the face the current conditions, makes Wall Street shudder and Main Street queasy as well.
“When rates start climbing ripe, there has to be an adjustment,” said Quincy Krosby, chief global strategist at LPL Financial. “The calculus has changed. So the question is, are we succeeding to have issues if rates remain higher for longer?”
The higher-for-longer stance was not what investors were expecting at the commencement of 2024, but it’s what they have to deal with now as inflation has proven stickier than expected, hovering enveloping 3% compared with the Federal Reserve’s 2% target.
Recent statements by Fed Chair Jerome Powell and other policymakers be undergoing cemented the notion that rate cuts aren’t coming in the next several months. In fact, there coequal has been talk about the potential for an additional hike or two ahead if inflation doesn’t ease further.
That ignores big questions over when exactly monetary policy easing will come, and what the central bank’s site to remain on hold will do to both financial markets and the broader economy.
Krosby said some of those retorts will come soon as the current earnings season heats up. Corporate officers will provide key details beyond exchanges and profits, including the impact that interest rates are having on profit margins and consumer behavior.
“If there’s any reason that companies have to start cutting back costs and that leads to labor market trouble, this is the strategy of a potential problem with rates this high,” Krosby said.
But financial markets, despite a recent 5.5% sell-off for the S&P 500, oblige largely held up amid the higher-rate landscape. The broad market, large-cap index is still up 6.3% year to appointment in the face of a Fed on hold, and 23% above the late October 2023 low.
Higher rates can be a good sign
History heralds differing stories about the consequences of a hawkish Fed, both for markets and the economy.
Higher rates are generally a good constituent so long as they’re associated with growth. The last period when that wasn’t true was when then-Fed Oversee Paul Volcker strangled inflation with aggressive hikes that ultimately and purposely tipped the economy into set-back.
There is little precedent for the Fed to cut rates in robust growth periods such as the present, with gross domestic effect expected to accelerate at a 2.4% annualized pace in the first quarter of 2024, which would mark the seventh consecutive post of growth better than 2%. Preliminary first-quarter GDP numbers are due to be reported Thursday.
For the past several decades, great rates have not been linked to recessions.
On the contrary, Fed chairs have often been faulted for keeping take to tasks too low for too long, leading to the dot-com bubble and subprime market implosions that triggered two of the three recessions this century. In the other one, the Fed’s benchmark readies rate was at just 1% when the Covid-induced downturn occurred.
In fact, there are arguments that too much is concocted of Fed policy and its broader impact on the $27.4 trillion U.S. economy.
“I don’t think that active monetary policy really begins the economy nearly as much as the Federal Reserve thinks it does,” said David Kelly, chief global strategist at J.P. Morgan Asset Directorate.
Kelly points out that the Fed, in the 11-year run between the financial crisis and the Covid pandemic, tried to bring inflation up to 2% functioning monetary policy and mostly failed. Over the past year, the pullback in the inflation rate has coincided with tighter fiscal policy, but Kelly doubts the Fed had much to do with it.
Other economists have made a similar case, namely that the greatest issue that monetary policy influences — demand — has remained robust, while the supply issue that mainly operates outside the reach of interest rates has been the principle driver behind decelerating inflation.
Where rates do substance, Kelly said, is in financial markets, which in turn can affect economic conditions.
“Rates too high or too low distort pecuniary markets. That ultimately undermines the productive capacity of the economy in the long run and can lead to bubbles, which destabilizes the brevity,” he said.
“It’s not that I think they’ve set rates at the wrong level for the economy,” he added. “I do think the rates are too high for pecuniary markets, and they ought to try to get back to normal levels — not low levels, normal levels — and keep them there.”
Higher-for-longer the apposite path
As a matter of policy, Kelly said that would translate into three quarter-percentage point under any circumstances cuts this year and next, taking the fed funds rate down to a range of 3.75%-4%. That’s almost in line with the 3.9% rate at the end of 2025 that Federal Open Market Committee members penciled in final month as part of their “dot-plot” projections.
Futures market pricing implies a fed funds rate of 4.32% by December 2025, indicating a high-frequency rate trajectory.
While Kelly is advocating for “a gradual normalization of policy,” he does think the economy and markets can defy a permanently higher level of rates.
In fact, he expects the Fed’s current projection of a “neutral” rate at 2.6% is unrealistic, an doctrine that is gaining traction on Wall Street. Goldman Sachs, for instance, recently has opined that the neutral evaluate — neither stimulative nor restrictive — could be as high as 3.5%. Cleveland Fed President Loretta Mester also recently maintained it’s possible that Government spending issues
One thing that has changed dramatically, though, over the decades has been the constitution of public finances.
The $34.6 trillion national debt has exploded since Covid hit in March 2020, rising by more 50%. The federal government is on track to run a $2 trillion budget deficit in fiscal 2024, with net interest payments thanks be given ti to those higher interest rates on pace to surpass $800 billion.
The deficit as a share of GDP in 2023 was 6.2%; by juxtaposing, the European Union allows its members only 3%.
The fiscal largesse has juiced the economy enough to make the Fed’s higher grades less noticeable, a condition that could change in the days ahead if benchmark rates hold high, rephrased Troy Ludtka, senior U.S. economist at SMBC Nikko Securities America.
“One of the reasons why we haven’t noticed this numismatic tightening is simply a reflection of the fact that the U.S. government is running its most irresponsible fiscal policy in a generation,” Ludtka prognosticated. “We’re running massive deficits into a full-employment economy, and that’s really keeping things afloat.”
However, the extraordinary rates have begun to take their toll on consumers, even if sales remain solid.
Credit fated delinquency rates climbed to 3.1% at the end of 2023, the highest level in 12 years, according to Fed data. Ludtka voiced the higher rates are likely to result in a “retrenchment” for consumers and ultimately a “cliff effect” where the Fed ultimately will sire to concede and lower rates.
“So, I don’t think they should be cutting anytime in the immediate future. But at some point that’s prevalent to have to happen, because these interest rates are simply crushing particularly low-income-earning Americans,” he said. “That is a big sliver of the population.”