WisdomTree Minds on the Markets
Minds on the Markets
Minds on the Markets
Archive: July 5, 2023
Just How Bad Are Higher Rates?
We don’t think it’s an exaggeration to say that the “main event” for the U.S. financial markets over the last year and a half has been Fed rate hikes. With 500 basis points (bps) worth of increases in the Fed Funds Rate being implemented since March of last year, it is natural to think something is going to “break” somewhere along the way. Certainly, this year’s regional bank turmoil was an unintended consequence, but investors have been looking for the more obvious—let’s call it intended—consequence of higher rates, a recession.
It’s easy to look at an aggressive monetary policy tightening and come to the conclusion that, at some point, an economic downturn becomes more likely than not. However, as we like to say, what about the other side of that trade?
While the lion’s share of attention on rate hikes, especially those of historical proportion, is understandably coming from the negative side of the ledger, scant interest is given to the positive experience for consumers, i.e., heightened interest income levels. Indeed, the level of interest income that can now be attained by households is light years ahead of what could be earned prior to this round of Fed rate hikes. In addition, it comes in all shapes and sizes as well, but perhaps most importantly, it doesn’t require taking very much risk. To provide perspective, consumers can now receive 5% in money market funds and almost 5 1/2% in some t-bills. Let’s compare that to pre-rate hike yields in early 2022 when rates were hovering not too far above zero.
According to the Bureau of Economic Analysis (BEA), personal interest income has risen by more than $150 billion from the end of 2021 through Q1 of this year. However, more than 90% of this increase has occurred since the Fed ratcheted up the pace of rate hikes in May of last year. This number is most likely going to continue to rise when full Q2 data becomes available. In fact, BEA data just revealed last week that personal interest income has increased by another $17 billion during the April/May period. Arguably, one could make the case that interest income should have a nice long runway to the upside as households catch up with the prior Fed rate hikes and take advantage of yield levels that haven’t existed in some 15 years. And that’s not even counting the one, or even two, more rate hikes that Chairman Powell was talking about last week in Europe.
That’s just interest income; what about incomes overall? The combination of solid job gains, low unemployment and higher wages offers the consumption component for real gross domestic product (GDP) a rather noteworthy boost, as well. Total personal income has increased by a hefty $472 billion through the first five months of this year…that’s almost a half-trillion dollars! In fact, personal consumption expenditures rose at a solid +4.2% clip in Q1, with spending on both goods and services coming in on the plus side of the ledger. Goods outlays rose +6.0%, the first positive showing for this type of spending in over a year.
Does this mean the U.S. economy is out of the woods? No, not at all. However, concerns about “falling off the cliff” may have been alleviated.
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