If you’re old enough to remember the last Fed tightening cycle (there’s a joke there, don’t miss it), you doubtlessly recall the FOMC’s struggle to transmit policy restriction to households and corporates.
To be sure, smaller firms and households in the lower-half of the so-called “K-shaped” economy felt the squeeze, but blue-chip firms and well-to-do households were, I dare say, largely unaffected if you don’t count the impact of falling stock prices in 2022.
Indeed, America’s “haves” actually benefited from Fed hikes, as swollen corporate cash piles and, in the case of the household sector, money market funds, began to generate enormous monthly income streams.
On the other side of the ledger, debt servicing costs fell for blue-chip companies and well-off households thanks to the once-in-a-lifetime term-out and refi opportunity created in the wake of the pandemic by the Fed’s backstop for corporate credit and record-low mortgage rates, respectively.
This is a topic that’ll be relevant again in fairly short order assuming the Kevin Warsh Fed eventually moves to tighten policy further. With that in mind, I thought it worth updating one of my favorite 2022/2023 charts for 2026.
The figure above shows you the share of household debt in America that’s variable rate (grey shaded area), along with corporate interest payments as a share of profits (blue line).
Although rising mortgage rates have indeed impacted the household metric, it’s still only just now (and just barely) back to pre-COVID levels. Not surprisingly given how robust corporate bottom lines are, interest payments’ share of profits hit a new low in Q2 of this year.
What does all of that mean? Well, it’s pretty simple really. “Normally, higher rates slow the US economy by directly squeezing corporate profit margins, but corporate net interest payments remain [low],” SocGen’s Albert Edwards said this week.
The red line in the figure above’s another way to visualize the corporate interest payments metric. Edwards plotted it with the real funds rate. The point, obviously, is that the two series are now completely detached.
“To slow the economy, Fed Funds would have to rise higher than it would otherwise,” Albert went on, in the same note.
That, in turn, raises doubts about the Fed’s willingness to do what’s necessary to slow the economy in the event robust spending continues to create demand-pull risks in a supply-constrained environment.
It seems exceedingly unlikely, after all, that Donald Trump’s going to sit idly by as Warsh dials up rates by however much it’d take to turn the screws on America’s “haves” who, both in the household and corporate sectors, remain well insulated.
My fuzzy guessy feeling is that rising rates and the follow-on are likely to break something in the “financial economy” before it breaks anything in the “real economy”. Depending on what breaks, hopefully not AI data center financing!, we could see the real economy shrugging off the break and steaming forward with profits, growth, inflation, rates all higher for longer. In which case, we could see the stock market to bounce back from the breakage and follow profits higher, while bond investors suffer more years of indignities.
Could have some more Silicon Valley Bank situations
Is it even possible to raise rates high enough to slow down inflation without literally putting the people in the lower half, economically, into abject poverty? Could drive 150M people into soup lines.
Your title reminds me of s pretty good “runaway train” movie, “Unstoppable”.
I prefer nice road movies such as Duel or Killdozer. With a golden frond for lifetime achievement given to Hot Rods to Hell.
Of course you do! 🙂
All are family friendly. Suitable for all ages.
Is anyone old enough to remember the pre-Volker attempt to “slow the economy”? Most economists like Albert E predicted the economy would slow “next quarter or by midyear/yearend “at the latest” due to Fed tightening as the guns & butter economy kept rolling on in the face of methodical Fed tightening. It took a monetary shock from the Volker Fed to stop that era’s booming loan demand.
Thank goodness you’re making this argument. I’d love to see Kevin W pull off what’s probably necessary to cool the demand-side overheating. Like you, I seriously doubt Trump would countenance such independence.
Thanks for jogging some memories. Speaking from the viewpoint of someone who was a trader on.the commodies side, we were trading off of realized and anticipated inflation rather than loan demand.
Ah, such simpler times when high school boys in the UK, Brooklyn and HK could become apprentice financial traders.
Perhaps my market journey is completeting a 360 degree circle. It does look that way, no?
I’m old enuf. I built my life on the pile I made from Volcker’s efforts. He pushed rates to 20% in the commercial market. Then we got the long slide to comfort in the bond market.
The Fed is indeed limited in what it can do when the problems are war, tariffs/trade or budget deficits (i.e., driven by the executive/legislative branch) and nothing to do with the economic cycle.
Them breaking something financial, as John L. suggests, seem to be their ‘best’ option, to scare people into reining in spending/AI Capex. But boy is that a weird way to run an economy…
Welcome back, Frederic.
The President might do Warsh’s work for him. He has a track record of breaking things.