Why Interest Rate Hikes Have Little Impact on the U.S. Economy

Analysts Notebook wrote a column · Jul 31, 2023 09:08

The US economy is maintaining a steady course towards a desirable "soft landing," despite facing 11 interest rate hikes. In comparison, countries like the UK, where homeownership rates are high and mortgages are short-term, experience rapid negative effects from similar rate increases. Fortunately, the US has positioned itself to better withstand such rate shocks.

That's in large part because the U.S. spent the 15 years before the rate hikes steadily deleveraging and ensuring that debtors couldn't easily fall victim to a credit crunch.

The US economy has been relatively successful in dealing with the recent rate hikes by the Federal Reserve due to a combination of factors. Household and corporate debt is primarily fixed-rate, which means that debt payments do not immediately increase when interest rates rise. Moreover, total debt levels are lower than in previous years, which is surprising given that more than a decade of zero-interest rates provided businesses with an incentive to borrow heavily.

However, some industries, such as finance and commercial real estate, are experiencing difficulties as loans become more expensive. The loan market is generally floating-rate, which means that companies that have issued loans rather than bonds are now feeling the pinch. Industries with the highest degree of leverage are the ones most vulnerable to this pressure. Commercial real estate bankruptcies are increasing as building owners find it impossible to refinance their mortgages at affordable rates.

On the other hand, savers are benefiting from higher interest rates, receiving returns on their money that they could barely have dreamed of a year ago. Although the US economy has shown resilience thus far, it remains to be seen whether the Fed will continue to raise rates or reduce them again. While the current rate of economic growth is robust, there may be long-term consequences to businesses continuing to borrow at high rates. Consequently, investors and industry leaders will need to stay vigilant regarding how future rate hikes might impact various sectors of the economy.

Seasonally adjusted; Core prices are excluding food and energy costs; Source: Commerce Department

Fresh economic data last week reinforced optimism that inflation can fall without the U.S. suffering a recession. Economic output accelerated in recent months on the back of solid consumer spending. Inflation cooled to 3% in June, according to the Fed's preferred gauge. And wage growth, while still elevated, slowed, the Labor Department said Friday.

We've seen so far the beginnings of disinflation without any real costs in the labor market. And that's a really good thing," Fed Chairman Jerome Powell said Wednesday after the central bank decided to raise interest rates to a 22-year high. He said his "base case" is that inflation can move back to the Fed's 2% target "without the kind of really significant downturn that results in high levels of job losses."