Do interest rates matter anymore?
The economy may be chugging along, but usury could bring a day of reckoning.
The Federal Reserve hiked interest rates 11 times between March 2022 and January 2024. Short rates have gone from zero to 5.5%. Meanwhile, the economy is growing at close to 3%. Unemployment hasn’t surged. Commodities are booming. Stocks hit an all-time high at the end of March. To borrow from “When Harry Met Sally" (1989), if that’s the outcome of higher rates, “I’ll have what she’s having."
As late as December, futures markets were expecting six rate cuts in 2024, according to Barron’s. After three monthly readings of more than 3% of “hot" inflation, Goldman Sachs now expects only two cuts. Fed Chairman Jerome Powell said it is “likely to take longer than expected" to have confidence that inflation is slain and cut rates. Former Treasury Secretary Lawrence Summers even thinks there’s a chance for a rate hike this year.
For almost 18 months, the yield curve has been inverted, which usually means a recession is coming. Still, the economy goes chug, chug, puff, puff like the little engine that could. Sadly, it’s the same for federal spending.
Thirty-year mortgage rates are more than 7%, up from roughly 3% at the start of 2022, so surely home prices are down, right? Wrong. The median home price was $384,500 in March, up from $350,000 at the start of 2022. Supply is limited because those with 3% mortgages are staying put with low payments.
Retail sales were up big again in March. Credit-card debt is a record $1.3 trillion, but note the Philadelphia Fed reported that late last year, credit-card delinquency rates (30, 60 and 90 days past due) were over 3%, numbers not seen since 2012. Keep an eye on that.
Global energy demand remains strong. Oil is pushing $85; I recently paid $6.39 a gallon for premium gasoline. Gold is shining. A side note: As Iranian drones headed toward Israel, Bitcoin prices dropped 10%—not quite a store of value. Auto sales were up, year over year, in March. Interest rates may matter but not as much.
Some markets are getting blasted. Commercial real estate is a mess. An office building in Baltimore is for sale at $1.5 million. True, it’s only Baltimore—but even New York isn’t immune: A Class A office space at 750 Lexington Avenue in Manhattan was recently valued at $50 million, down from $300 million in 2015. To be sure, office problems are as much from the nasty headwinds of remote work as they are from higher rates.
High interest rates used to cause recessions as carrying inventory got more expensive and orders halted. Most retailers now use just-in-time deliveries in their supply chains to minimize inventory costs. Autos are exposed, but manufacturers often subsidize dealer inventories and offer cheap loans.
Aren’t banks at risk when rates go up? Some. March 2023 saw a flurry of failures at such regional banks as Silicon Valley and Republic, mainly those that didn’t hedge their interest-rate risk. Big banks hedge, so they aren’t as exposed to rate hikes. They mainly care about the spread between how much it costs them to borrow vs. rates they can charge to lend—the net interest margin. Recent bank earnings have been a mixed bag, but it’s certainly no financial crisis.
What about Amazon? Facebook? Google? Apple? Despite huge capital expenses for data centers or parts for phones, they are all flush with cash. Meanwhile, advertising is growing, although on television I’m seeing fewer Chevy ads and more plugs for Progressive insurance—even though, or maybe because, auto-insurance costs are up 22% from last year. The service economy is winning. Video is increasingly streamed and less about physically putting up antennas or laying cable.
We are now an economy of logistics, online sales and electronic delivery. Manufacturing economies such as China and much of Europe are much more interest-rate-sensitive than the U.S. Higher interest rates may matter, but for an increasingly smaller portion of our economy.
The Fed’s interest rates are a blunt instrument anyway. Bureaucrats now try to control the economy by tinkering with the money supply and paying interest on excess reserves—Treasury uses reverse repos to soak up liquidity. These are more behind-the-scenes tools than the headline Fed power interest-rates moves we all focus on.
There is an area in which interest rates really do matter: federal budget deficits, unnecessarily boosted by electric vehicle subsidies and other green goo. For perhaps the first time, interest payments this year will be larger than defense spending. This is one reason recent Treasury auctions have seen weak demand, sending long rates higher. Here’s a silver lining: The economy might be fine, but higher rates may finally bring a day of reckoning to rein in the tax-and-spenders.
Write to kessler@wsj.com.
