Be careful what you wish for. After not getting much sun in April, May, and June, we transition right into a “heat dome” in Encinitas. We hope you are staying cool.
Should we cancel the recession warning? It sure seems like it after seeing the performance of the stock market this year as well as some of the other economic news this month.
The Federal Reserve hiked rates by .25% again this week which was a virtual certainty. The bigger news? They are no longer forecasting a recession in the US. They think we “have a shot” for inflation to return to target without the job losses they were anticipating before.
Earnings and GDP numbers were also decent this month. The Dow Jones Industrial Average also rose for 13 straight days – the longest streak since 1987. It’s still trailing the S&P 500 and NASDAQ year-to-date but it’s a move in the right direction.
How did the forecasters get this so wrong? If you remember, 70% of economists surveyed by Bloomberg were predicting a recession this year. The biggest thing they failed to anticipate was the impact, or lack thereof, of a rapid rise in interest rates on both corporations and consumers. When borrowing costs go up that much that quickly, that tends to lead to less borrowing, less spending, layoffs etc.
However, turns out that corporations were able to lock up cheap funding before interest rates went up.
Wall Street economists and billionaire investors repeatedly warned over the last year that the Federal Reserve’s rapid interest rate hikes have made avoiding an economic downturn nearly impossible. But that downturn has yet to arrive, and now, Edwards has spotted another economic oddity that is helping many US corporation avoid the worst of the Fed’s wrath and stave off a recession – at least for now.
“…some 80% of S&P 500 companies’ debt has a fixed interest rate, which means the S&P 500 is relatively insensitive to interest rates”.
America Has Avoided a Recession
This is obviously helpful for corporate earnings and can explain partly why the markets have been on a tear this year. But what about consumers? Consumer spending accounts for roughly 70% of GDP – shouldn’t a big increase in borrowing costs impact us? Again, maybe not as much as you think.
In the depths of the pandemic, Alex and Cynthia Durbin refinanced their mortgage at 2.75%. They built up their savings by spending less, then paid off a car loan and student debt.
That meant the family’s balance sheet didn’t take a hit when the Federal Reserve started aggressively raising interest rates last year in an effort to cool inflation. The Fed on Wednesday raised rates to a 22-year high, the 11th increase since March 2022. Though most things cost more now, the Durbins still have room in their budget to dine out with their three young children and go on vacation a few times a year.
“It’s given us a tremendous amount of breathing room,” Durbin said of his mortgage rate.
What Fed Hikes? Much of America’s Consumer Debt Is Still Riding Ultra-low Interest Rates
How much can rising interest rates hurt consumers if so many locked in ultra-low rates back in 2020 and 2021? Take a look at the numbers:
– 91.8% of outstanding mortgages are below 6%. The current new mortgage rate is 6.71%.
– 82.4% are below 5%
– 62% are below 4%
– 23.5% are below 3%.
As you’ll see below, household balance sheets are in much better shape than in prior periods like the 2008 financial crisis. Delinquencies for things like auto loans and credit cards are starting to creep up, but remain well under long term averages.
This can also explain why the analysts that called for a housing crash haven’t gotten this right either.
“High mortgage rates are a double whammy because they’re discouraging both buyers and sellers – and they’re discouraging sellers so much that even the buyers who are out there are having trouble finding a place to buy.
The lock-in effect is unlikely to go away in the near future.”
If no one is selling their homes then it’s hard for prices to fall. Home prices are actually almost back to all-time highs.
That’s not to say we’re out of the woods yet. While a lot of Americans have been shielded from higher interest rates, most households have seen cost increases – especially at the lower income level. Higher rates for car loans (7.2% average for new, 11% for used), credit card interest (20.44%), and the restarting of student loan payments (5.5%) are going to have an impact on the economy in some fashion. A recession will come eventually, but perhaps the worse-case scenario that everyone was predicting is off the table for now.
Let this be a lesson to all of us. Even if you were able to get the economic news ahead of time, the market has an uncanny ability to do the exact opposite of what you think it will do.
