Why the Fed keeping rates higher for longer may not be such a bad thing

With
the
economy
humming
along
and
the
stock
market,
despite
some
recent
twists
and
turns,
hanging
in
there
pretty
well,
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
decide
to
keep
rates
where
they
are
for
even
longer,
and
go
through
all
of
2024
without
cutting?

It’s
a
question
that,
despite
the
current
conditions,
makes
Wall
Street
shudder
and
Main
Street
queasy
as
well.

“When
rates
start
climbing
higher,
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
going
to
have
issues
if
rates
remain
higher
for
longer?”

The
higher-for-longer
stance
was
not
what
investors
were
expecting
at
the
beginning
of
2024,
but
it’s
what
they
have
to
deal
with
now
as
inflation

has
proven
stickier
than
expected,
hovering
around
3%
compared
with
the
Federal
Reserve’s
2%
target.

Recent
statements
by
Fed
Chair

Jerome
Powell
and
other
policymakers
have
cemented
the
notion
that

rate
cuts
aren’t
coming
in
the
next
several
months.
In
fact,
there
even
has
been
talk
about
the
potential
for

an
additional
hike
or
two
ahead
if
inflation
doesn’t
ease
further.

That
leaves
big
questions
over
when
exactly
monetary
policy
easing
will
come,
and
what
the
central
bank’s
position
to
remain
on
hold
will
do
to
both
financial
markets
and
the
broader
economy.

Krosby
said
some
of
those
answers
will
come
soon
as
the
current
earnings
season
heats
up.
Corporate
officers
will
provide
key
details
beyond
sales
and
profits,
including
the
impact
that
interest
rates
are
having
on
profit
margins
and
consumer
behavior.

“If
there’s
any
sense
that
companies
have
to
start
cutting
back
costs
and
that
leads
to
labor
market
trouble,
this
is
the
path
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,

have
largely
held
up
amid
the
higher-rate
landscape.
The
broad
market,
large-cap
index
is
still
up
6.3%
year
to
date
in
the
face
of
a
Fed
on
hold,
and
23%
above
the
late
October
2023
low.

History
tells
differing
stories
about
the
consequences
of
a
hawkish
Fed,
both
for
markets
and
the
economy.

Higher
rates
are
generally
a
good
thing
so
long
as
they’re
associated
with
growth.
The
last
period
when
that
wasn’t
true
was
when
then-Fed
Chair
Paul
Volcker
strangled
inflation
with
aggressive
hikes
that
ultimately
and
purposely
tipped
the
economy
into
recession.

There
is
little
precedent
for
the
Fed
to
cut
rates
in
robust
growth
periods
such
as
the
present,
with
gross
domestic
product
expected
to
accelerate
at
a
2.4%
annualized
pace
in
the
first
quarter
of
2024,
which
would
mark
the
seventh
consecutive
quarter
of
growth
better
than
2%.
Preliminary
first-quarter
GDP
numbers
are
due
to
be
reported
Thursday.

For
the
past
several
decades,
higher
rates
have
not
been
linked
to
recessions.

On
the
contrary,
Fed
chairs
have
often
been
faulted
for
keeping
rates
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
funds
rate
was
at
just
1%
when
the
Covid-induced
downturn
occurred.

In
fact,
there
are
arguments
that
too
much
is
made
of
Fed
policy
and
its
broader
impact
on
the
$27.4
trillion
U.S.
economy.

“I
don’t
think
that
active
monetary
policy
really
moves
the
economy
nearly
as
much
as
the
Federal
Reserve
thinks
it
does,”
said
David
Kelly,
chief
global
strategist
at
J.P.
Morgan
Asset
Management.

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%
using
monetary
policy
and
mostly
failed.
Over
the
past
year,
the
pullback
in
the
inflation
rate
has
coincided
with
tighter
monetary
policy,
but
Kelly
doubts
the
Fed
had
much
to
do
with
it.

Other
economists
have
made
a
similar
case,
namely
that
the
main
issue
that
monetary
policy
influences
—
demand
—
has
remained
robust,
while
the
supply
issue
that
largely
operates
outside
the
reach
of
interest
rates
has
been
the
principle
driver
behind
decelerating
inflation.

Where
rates
do
matter,
Kelly
said,
is
in
financial
markets,
which
in
turn
can
affect
economic
conditions.

“Rates
too
high
or
too
low
distort
financial
markets.
That
ultimately
undermines
the
productive
capacity
of
the
economy
in
the
long
run
and
can
lead
to
bubbles,
which
destabilizes
the
economy,”
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
financial
markets,
and
they
ought
to
try
to
get
back
to
normal
levels
—
not
low
levels,
normal
levels
—
and
keep
them
there.”

As
a
matter
of
policy,
Kelly
said
that
would
translate
into
three
quarter-percentage
point
rate
cuts
this
year
and
next,
taking
the
fed
funds
rate
down
to
a
range
of
3.75%-4%.
That’s
about
in
line
with
the
3.9%
rate
at
the
end
of
2025
that
Federal
Open
Market
Committee
members
penciled
in
last
month
as
part
of
their “dot-plot”
projections.

Futures
market
pricing
implies
a
fed
funds
rate
of
4.32%
by
December
2025,
indicating
a
higher
rate
trajectory.

While
Kelly
is
advocating
for “a
gradual
normalization
of
policy,”
he
does
think
the
economy
and
markets
can
withstand
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
idea
that
is
gaining
traction
on
Wall
Street.
Goldman
Sachs,
for
instance,
recently
has
opined
that
the
neutral
rate
—
neither
stimulative
nor
restrictive
—
could
be
as
high
as
3.5%.
Cleveland
Fed
President
Loretta
Mester
also
recently
said
it’s
possible
that

the
long-run
neutral
rate
is
higher.

That
leaves
expectations
for
Fed
policy
tilting
toward
cutting
rates
somewhat
but
not
going
back
to
the
near-zero
rates
that
prevailed
in
the
years
after
the
financial
crisis.

In
fact,
over
the
long
run,
the
fed
funds
rate
going
back
to
1954
has
averaged
4.6%,
even
given
the
extended
seven-year
run
of
near-zero
rates
after
the

2008
crisis
until
2015.

One
thing
that
has
changed
dramatically,
though,
over
the
decades
has
been
the
state
of
public
finances.

The
$34.6
trillion
national
debt
has
exploded
since
Covid
hit
in
March
2020,
rising
by
nearly
50%.
The
federal
government
is
on
track
to
run
a
$2
trillion
budget
deficit
in
fiscal
2024,
with
net
interest
payments
thanks
to
those
higher
interest
rates
on
pace
to
surpass
$800
billion.

The
deficit
as
a
share
of
GDP
in
2023
was
6.2%;
by
comparison,
the
European
Union
allows
its
members
only
3%.

The
fiscal
largesse
has
juiced
the
economy
enough
to
make
the
Fed’s
higher
rates
less
noticeable,
a
condition
that
could
change
in
the
days
ahead
if
benchmark
rates
hold
high,
said
Troy
Ludtka,
senior
U.S.
economist
at
SMBC
Nikko
Securities
America.

“One
of
the
reasons
why
we
haven’t
noticed
this
monetary
tightening
is
simply
a
reflection
of
the
fact
that
the
U.S.
government
is
running
its
most
irresponsible
fiscal
policy
in
a
generation,”
Ludtka
said. “We’re
running
massive
deficits
into
a
full-employment
economy,
and
that’s
really
keeping
things
afloat.”

However,
the
higher
rates
have
begun
to
take
their
toll
on
consumers,
even
if
sales
remain
solid.

Credit
card
delinquency
rates
climbed
to
3.1%
at
the
end
of
2023,
the
highest
level
in
12
years,
according
to
Fed
data.
Ludtka
said
the
higher
rates
are
likely
to
result
in
a “retrenchment”
for
consumers
and
ultimately
a “cliff
effect”
where
the
Fed
ultimately
will
have
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
going
to
have
to
happen,
because
these
interest
rates
are
simply
crushing
particularly
low-income-earning
Americans,”
he
said. “That
is
a
big
portion
of
the
population.”