Surging Interest Rates Pose Challenges for the US Economy
Surging interest rates are becoming a growing concern for the US economy, raising challenges for the Federal Reserve and threatening to destabilize inflation control efforts without inducing a deep recession. The yield on the benchmark 10-year Treasury note has been steadily rising since mid-summer, causing borrowing costs across the economy to spike. This includes mortgages, auto loans, and credit card debt, which have all increased in response. The collective impact of higher rates could also undermine government finances.
The rise in longer-term rates is occurring alongside other threats, such as higher gas prices, the resumption of student loan payments, an ongoing strike by autoworkers, and the possibility of a government shutdown next month. All these factors could leave consumers with less disposable income to bolster economic growth.
The strike by the United Auto Workers, now in its third week with no resolution in sight, may hamper vehicle sales in the coming months. Additionally, the risk of a government shutdown, narrowly avoided last weekend, still looms large, particularly with the chaos surrounding the leadership of the House of Representatives. Far-right Republican House members deposed their leader, Rep. Kevin McCarthy, on Tuesday for collaborating with Democrats to temporarily avert a shutdown.
Despite a robust summer, fueled by strong consumer spending on travel, concert tours, and blockbuster movies, economic growth is projected to slow down to a meager 0.7% annual rate in the final quarter of the year. Goldman Sachs estimates that the economy grew by a healthy 3.5% annual rate in the July-September period. However, the combination of high borrowing rates and comparatively elevated inflation levels is expected to make consumers more cautious with their spending. Consumer spending constitutes around 70% of economic growth.
On Friday, the government will release the September jobs report, which will provide insight into how employers are navigating the current turmoil with their hiring plans. Economists predict that the report will show the addition of a solid 162,000 jobs last month, with the unemployment rate dipping to 3.7%, near a half-century low. However, the significant increase in borrowing costs could aggravate the economic slowdown.
The yield on the 10-year Treasury reached a 16-year high of 4.8% on Tuesday, up from April’s 3.3%. Additionally, the average 30-year fixed-rate mortgage rose to 7.3%, the highest rate in 23 years, according to Freddie Mac. Loretta Mester, president of the Federal Reserve Bank of Cleveland, acknowledged that the surge in long-term rates would influence their policy decisions, suggesting that it may lead the Fed to abandon another rate hike.
Financial analysts attribute the rapid increase in lending rates to several factors. Firstly, the Federal Reserve has repeated its intention to maintain its key rate at a heightened level for a much longer period than anticipated by financial markets earlier this year. Moreover, the economy has proven resilient even in the face of rate hikes, creating the impression that it can withstand increased borrowing costs.
The economy’s ability to thrive despite higher rates could mean that borrowing costs will remain higher than what was experienced post the 2008-2009 financial crisis. During that time, the 10-year Treasury yield dropped to as low as 1.5%, and mortgage rates fell below 3% during the pandemic.
The Treasury Department is also auctioning off more debt to cover the growing budget deficit, which is projected to reach $1.5 trillion this year and rise further in 2024. This increase in the supply of Treasurys, coupled with the reduction in bond holdings by the Fed and reduced purchases by overseas buyers, is pushing rates higher to attract investors.
Gennadiy Goldberg, head of US rates strategy at TD Securities, stated, “All of that is driving these fears of higher rates, and no one knows when it’s going to stop.” Benson Durham, former Fed economist and head of global policy at Piper Sandler, suggested that long-term rates are rising due to investors deeming it riskier to hold government debt for an extended period during periods of high volatility and uncertainty, as is currently the case.
Durham observed that Fed officials have shifted from a predictable pattern of rate hikes to a more uncertain one. Chair Jerome Powell repeatedly emphasized that the central bank’s decisions are data-dependent, meaning they will increase rates further only if economic data supports it or halt rate hikes if inflation drops.
In addition to higher interest rates, student loans are also expected to impact the economy significantly. Approximately 43 million people will resume paying several hundred dollars monthly to the government, potentially reducing annual growth for the October-December quarter by half a percentage point. The rising cost of gas could further reduce growth by 0.3 percentage points in both the fourth quarter and the first three months of next year, according to Goldman Sachs.
If a government shutdown were to occur next month, it could detract 0.2 percentage points from growth for each week it lasts. An economist at Oxford Economics estimated these figures. David Page, head of macro research at AXA IM, a London-based investment manager, anticipates that the economy will shrink in the fourth quarter and believes that the narrative will shift before the year ends. He expects fears of an impending downturn rather than optimism for a “soft landing” of curbed inflation without a recession.
In conclusion, surging interest rates pose significant challenges for the US economy, potentially derailing efforts to control inflation without causing a deep recession. The collective impact of higher rates across the economy, coupled with other threats such as rising gas prices, the resumption of student loan payments, an ongoing autoworkers’ strike, and the possibility of a government shutdown, could hinder economic growth. It remains to be seen how employers will factor in these issues in their hiring plans, and the Federal Reserve faces difficult decisions regarding interest rates amid increased borrowing costs.