LONDON, Sept 11 (Askume) – If significant interest rate hikes in recent years have failed to slow U.S. economic growth, it is fair to ask whether raising interest rates in a recession would do the same.
One of the mysteries of the past two years has been how the 5% tightening policy implemented by the Federal Reserve between March 2022 and July 2023 had so little effect on the overall economy.
Despite lower borrowing, US real GDP grew at an annual rate of more than 2% in seven of the eight quarters through mid-2022, and that number is expected to rise further in the three months through the end of September.
Despite seasonal fluctuations, the stock remains close to all-time highs.
This suggests that the economy is becoming less sensitive to changes in short-term borrowing costs. If that is the case, policymakers should worry that any recession from now on – even a cyclical one – could be triggered by a loosening of monetary policy.
There are several theories about this resistance to higher interest rates: the uniqueness of the COVID-19 pandemic years, with ample household savings and government spending before austerity; high levels of U.S. fixed-rate debt, particularly in mortgage businesses, improving overall liquidity levels; offsetting the losses to small businesses from higher debt-servicing costs.
The last of the three is perhaps the most telling. A recent report from the International Monetary Fund showed that during the tightening cycle, net interest paid by US companies as a share of GDP fell by half. Other research suggests that by 2022, US corporate net interest payments as a proportion of cash flow will also fall to their lowest level in nearly 70 years.
Decreased sensitivity
So what is its importance?
Interest rates are obviously going to stay low, with the Fed expected to begin cutting rates next week . But given that raising interest rates will have limited impact on the economy, some analysts believe that if a recession spreads, the Fed may need to cut interest rates to very low levels to stimulate the economy.
Others may argue that the effects of rising interest rates are delayed, with the delayed effect over the last two years being evident in the decline in the levels of cash on the balance sheets of some households and businesses.
But corporate borrowers have had no trouble repaying their loans, even if they have to refinance at higher rates. 59 new loans worth more than $81 billion were issued last week, the fifth-largest weekly volume ever for investment-grade companies, according to the IFR.
Some investors believe that given this complex situation, the Fed’s thinking should be more cautious than the current market outlook.
Yves Bonzon, chief investment officer at Julius Baer, believes that the uncertainty about the transfer of monetary policy to the private sector is “too high” because, as he puts it, rising interest rates will be driven primarily by “debt”. This is to curb “income-driven economic expansion”, not “income-driven economic expansion”.
“If the real economy’s sensitivity to interest rates is abnormally low, it is unclear how asset prices will react if the Fed meets market expectations and cuts interest rates sharply.”
Bonzon’s main point is that in the absence of a recession, the Fed’s easing policy could stimulate already accelerating private sector credit growth, boost the housing market and related sectors, and even benefit the buyout and private equity markets that are affected by interest rates but also be resurgent.
“Against this backdrop, the Fed should be cautious to avoid a boom-bust cycle in asset prices,” he said, adding that an initial three-quarter rate cut would be sufficient and the Fed would continue to evaluate the situation.
For BlackRock credit strategists Amanda Lynam and Dominic Blee, it all depends on what you think the Fed is actually doing.
Is this done to mitigate signs of an impending recession or to rebalance after inflation has moderated?
If this first option were to occur, it would likely result in a sharp cut in policy rates but also a nearly doubling of high-yield debt spreads due to recession fears.
On the other hand, BlackRock strategists believe that if the Fed returns to “normal”, its final interest rate may increase significantly, reaching around 3.5%, while credit spreads will remain at their original level.
Whatever you say, it’s clear that no one — including the Fed — is entirely sure how this story will unfold in the coming year. That means investors should expect more volatility in a few months than they do now.
The views expressed in this article are those of the author, a Askume columnist
The views expressed are those of the author. They do not reflect the views of Askume News, which is committed to integrity, independence and non-partisanship in accordance with the principles of trust.
