Earlier this week, a reader asked for my opinion on a “heretical” notion: The idea that high rates may be facilitating, rather than impeding, economic activity in the US.
The impetus for the reader inquiry was an energetic article which anchored the April 16 edition of Bloomberg’s “Evening Briefing,” one of countless mailers you can sign up for if you want to treat your inbox like a force-fed foie gras duck.
The piece, called “What If Fed Rate Hikes Are Actually Sparking US Economic Boom?” is indeed worth a mention. And for about five minutes, I debated whether to eschew sarcastic wit in favor of an academic, quasi-reverential cadence while mentioning it. Then I remembered who I am: A sarcastic, irreverent solitudinarian for whom smug is a point of pride.
With that in mind, I didn’t actually have to read the Bloomberg piece. Because I wrote it. Not literally, but if you stitched together enough articles published across these duly consecrated pages over the past two and a half years (give or take), you could make a quilt that reads quite a bit like it.
As heterodoxy goes, this is pretty straightforward — to the point of being self-evident. Which, incidentally, goes a long way towards explaining why it took so long for everybody to come around to it. “Common sense ain’t so common,” after all.
Jerome Powell afforded households and corporates a generational (you might even call it unprecedented) opportunity to insulate themselves when, in 2020 and 2021, the Fed helped push mortgage rates to record lows and backstopped corporate credit. The familiar (indeed, I’ve worn it out by now) figure below illustrates the point.
The share of variable-rate US household debt fell to just 10% in 2021, while corporate interest payments as a share of profits embarked on a steady decline to a new low near 5%.
You can illustrate the dynamic any number of ways. Allow me to walk through a few of the relevant charts for anyone who might’ve missed them. There’s probably some utility in having them all in one place anyway.
The figure below shows the effective rate on America’s mortgage loan stock.
Over the space of 40 years, that metric fell from north of 11.5% to less than 3.31% on the eve of the Fed’s first rate hike.
In America, the vast majority of that’s fixed-rate. Powell can raise rates to 30% and it won’t matter for that portion of the country’s debt stock.
The figure below plots corporate profit margins with the same interest share series shown in the first chart above.
Thanks in no small part to the impact of the terming-out seen in 2020 and 2021, profitability scaled new highs on the juxtaposition between falling interest costs and rising revenue courtesy of the pricing power bonanza that typified the post-pandemic US economy.
Between heavy borrowing (again, at very low rates) and robust profits (note that the pricing power boom preceded the run-up in wage bills), some corporates were left with massive cash piles. Households were likewise flush thanks to a combination of two huge spikes in the saving rate, fiscal transfer payments and, later, surging wage growth.
Plainly, the benefits weren’t equally distributed. Cash buffers for low-income households were eventually depleted. And the “have-nots” of the corporate world didn’t enjoy the same capital markets access (let alone the same favorable borrowing costs) as their larger, higher-rated peers, and so didn’t have as much in their corporate treasuries. But you get the point: The conditions were in place for the Fed to boost activity with rate hikes.
As cash rates started to climb, yields on money market funds and corporate cash piles rose too, creating an increasingly attractive arb. On one side: Very low fixed-rate payments (mortgages at 3.3% for households and sub-4% coupons for corporates). On the other: Ever higher yields on riskless, bloated cash balances.
The figure above estimates the monthly windfall from money market funds as of ~end-Q3 2023: In excess of $20 billion every month for somebody.
If that somebody’s households, it’s free money, and to the extent free money’s synonymous with disposable income and, in turn, demand, well… that’s one plausible explanation for the “inexplicably” resilient US consumer.
As I put it three months ago in one of countless articles documenting these dynamics, households with very large money market fund balances are enjoying a monthly income stream that may well be supporting consumption.
On the corporate side, consider the figure below, from SocGen. It shows cash rates with the weighted average corporate coupon.
There again, corporates are paying less to service their debt than they’re getting on their cash piles. In terms of the effective rate, anyway.
Corporates which termed-out their debt profiles in 2020 and 2021 when issuance boomed are able to generate a hefty return on whatever portion of their cheap borrowed money is parked in cash.
Consider another figure from SocGen (to their great credit, several of the bank’s strategists have been all over this story pretty much from the beginning of the Fed’s hiking cycle). The chart below is a stylized representation of interest earned from S&P 500 cash piles versus interest paid by both high grade and junk borrowers.
The point (obviously) is to show how rapidly interest receipts have probably risen. To the extent that money’s being used to fund operations, that too is helpful, as it delays the need to recognize a higher cost of capital through new borrowing at higher rates.
I summed all of this up on January 17, when I wrote: “In both cases (i.e., for well-off households and high quality corporates), higher rates are effectively a boon to the economy.”
Writing on Tuesday, Bloomberg’s Ye Xie presented that self-evident conclusion as (and this is a direct, if spliced-together, quote) “a radical, fringe theory.” “Maybe the economy isn’t booming despite higher rates but rather because of them,” he exclaimed.
Yes, maybe! Maybe when you rapidly ratchet up the rate on risk-free cash savings held by households and corporates such that you’re handing them more money than they need to service the debt you let them refinance at record-low rates, you’ll end up with resilient consumers and corporates, at least at the aggregate level.
As Bloomberg was generous enough to point out, Warren Mosler (who I can confirm visited these pages at least once since the pandemic) figured this out decades ago. His superstar disciple, Stephanie Kelton, spent the better part of her career preaching it (actually a corollary of it to be more precise) to anyone who bothered to listen, an audience which grew large enough to land her atop The New York Times bestseller list.
But if you’re the financial media, it has to come from a former Bay Street market maker and, more importantly, a billionaire short-seller, before you’ll report it as anything other than a lunatic “fringe theory.”
Ye quoted Kevin Muir. “The reality is people have more money,” Kevin remarked.
Mmm, hmm. They sure do, Kevin. Well, some of them do, anyway. The ones who “count” in America, which is to say rich people. Rich people like David Einhorn, whose legendary analytical skills open the door to the kind of Bertrand Russell-level observations that’ll land you at the center of a Bloomberg article. Ye celebrated one such Einhorn epiphany.
Currently, Einhorn calculates, US households are enjoying interest income on more than $13 trillion of short-term interest-bearing assets. On David’s math, $13 trillion is “almost triple” $5 trillion (I checked that, it’s sound). $5 trillion is the amount of ex-mortgage consumer debt Americans are compelled to service.
If you make some assumptions about rates, then run all the numbers through an Nvidia-enabled flux capacitor (or your iPhone calculator, whichever’s more convenient), you can reckon a rough estimate of the annual windfall to US households from the rate arb I’ve spent so much time discussing over the past 24 months. That estimate: About $400 billion.
All of this might seem easy enough to grasp, and a lot of readers probably came around to this “radical,” “fringe,” “heresy” a long time ago, but if that’s you, just remember that if it seems like common sense or worse, if it seems self-evident, it’s probably wrong.
As Bloomberg noted, sobering up, “the vast bulk of economists and investors still firmly believe in the age-old principle that higher rates choke off growth.”
It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so.
Adding to the point, these rate hikes were telegraphed to such an extent, in order to lessen their impact due to fear of financial cataclysm, that anybody who dared to listen adjusted prior to the move.
Thanks for the funny re-telling of “I told you so” =p
Presumably Powell and the Federal Reserve voting and non-voting members are aware of this.
Which leads me to ask- what do you (H) think is their rationale for stay
…for staying at this level of rates for an even longer period of time?
Perhaps their models have proven to be incapable of accounting for the impact of the interest rate changes thanks to the sheer speed and magnitude of the interest rate changes. Their models certainly did not properly did not properly handle the impact of higher rates on the housing market so that idea is not so far-fetched.
Ah, the perils of relying on models to explain something as overwhelmingly complex as global weather or the US economy.
If the possible pro-inflationary effect of higher rates has been discussed by FOMC, would we know from the minutes? Or is that naive?
So conversely if the Fed reduces rates then corporates and households would lose the incremental “cushion” from the interest income. But the reduction in rates would increase risky behavior due lower borrowing cost. Strange place to be in. It’s almost goldilocks-ish depending on your vantage point?
So money market interest rate at r*?
Bravo, Maestro! Thank you.
This is what you call a “mic drop” post. Another reminder I think worth repeating, 5% rates are not “high”. 5% was a low rate until the bankers broke the global economy and then a bunch of idiots let a spoiled self-obsessed idiot man child run the most powerful country on the planet during the worst pandemic in a 100 years.
Warren Moslter convertd me 25 years ago and I became a Stephanie Kelton accollyte. BUT the economics and the politics don’t match now. There is one vote for each individual – moe or most less – but about 70-80% of all individuals have a negative cash woth. If your cash balance is below zero and – even worse – if you are a renter you are screwed. H, you have showed a chart of the benefits of the COVID assistance in 2020 and through much 0f 2021 and pointed out how this money boosted consumption. The latest of thse that I remember shows that more than 80% had spent everything and were worse off than 2019 – more in debt. With credit card rates up they are hurting. For those voters – and it is more than 50% of all voters, things are worse now. Over 40% of outstanding cards are in a debit position at 22% average rate. You can count them as disbelievers and angry at Biden. The bottom 70% of the wealth ladder used to be Democrats. No longer. Powell has screwed the lesser-off majority.
Your post indeed paints a bleak picture. But the conclusion you draw in your last sentence isn’t correct. To the extent that it is correct, I’ll assume the outcome was inadvertant as opposed to the lesser-off majority being deliberately screwed for decades by Congress and corporations in their quest for campaign contributions and profits, respectively
It seems the 800lb gorilla in the room to solve this problem is taxation to suck up all the extra dollars at the top. Maybe the power of taxation should be given to the Fed/Treasury. Can you imaging if the Fed meeting were something like, “Next Quarter’s tax rates will be…” Obviously Congress is not doing their job. Federalism is the root of the problem. Low population states should not have same power as high population states. Just like states redraw voting districts, we should redraw the state lines in this country for a fairer more representative system. Wishful thinking…
I’m not sure there’s a worse democratic institution in a republic than the US Senate.
And I agree with you 100%. This country has outgrown the concept of “states” that were very important in helping to unify the country at its birth and for a century plus thereafter.
I agree the smartest thing to do here is raise taxes on the top 10%. A service tax on lawyers and accountants above 10k would help too. Meanwhile, Trump is promising to re-subsidize yachts and such…
Yes- this is the elephant in the living room…
As comedian Foster Brooks often said in his stuporous guise, “I’ll buy that for a dollar.” Actually, there is not really much to see here. The trick is not low cost borrowing, just a Weighted Average Cost of Capital below the return of any available asset. For decades financial theory has taught us that to invest profitably one just needs to buy any asset for which the forecast cash receipts have a present value return (IRR) above the investor’s WACC. Anywhere on the capital market line will do. Starting in the early 1980s many treasury bonds were available at a discount owing to high market rates. The required margin rules on such investments were 5% down. Margin lending could be had at a broker for about 200-250 bp above the T-bond coupon rates so investing 40% of the price of such bonds would cover one’s borrowing costs, leave a couple hundred bps of profit and offer huge prospects for capital gains in a year or two. I’m living off the results of repeated applications that strategy even now. The level of leverage determined the dollar outcome, just as it does with any leveraged buy. CEFs operate on this principle …. My doctoral mentor wrote books about leverage. Wonderful stuff.
Yes, leverage is wonderful…..until it isn’t.
Higher rates mean that I can finally have my house repainted. And a developing sinkhole managed. I don’t think I’m someone who “counts”, I’m someone who is not working due to age-related issues.
Also, I really appreciate the flux capacitor reference.
I see a steady stream of new corporate issues at 15 years, 6% YTM, and a few years call protection. More terming out, and no downside (for the issuer) with the call.