If you believe what the inverted Treasury yield curve is saying, you must believe that, eventually — but probably sooner rather than later — the Federal Reserve will start lowering interest rates in response to the economic recession it will have caused by raising rates by more than 400 basis points in the past year.
But based on the strength of the economy despite those higher rates, it’s looking more like rates well above 4% - and possibly 5% — are going to be around for a long time to come.
But that’s not necessarily such a bad thing. For all those younger than 40, 4-5% long-term interest rates had been the norm for decades.
It’s only in this century that we’ve become accustomed to super-low interest rates, engineered by an activist Fed to insulate consumers and the financial markets from seemingly one financial crisis after another.
But that era looks to be over. And it looks like we’re managing.
Even though inflation appears to have peaked and is moving steadily downward, the Fed is likely to keep rates fairly high for quite a while, certainly the rest of this year and probably 2024 and beyond, absent yet another global financial crisis, to make sure the inflationary beast is truly slayed.
Even on the unlikely chance that the federal government defaults on its debt later this year if Congress can’t agree to raise the debt ceiling, the Fed isn’t likely to start lowering rates for a long time, despite what many investors hope and the inverted yield curve would indicate.
As we know, an inverted yield curve is when short-term rates are higher than long-term rates, which is the exact opposite of the natural order of things.
Long-term debt usually carries higher rates because a lot more can go wrong over, say, 10 or 20 years, than it can over just a couple of years or less. But that’s not what we have now.
Long-term rates are lower than short-term because bond traders and investors believe that the Fed will throw the economy into recession, and then have to backtrack and start lowering rates, maybe in a year or two.
So better grab those high rates on short-term bonds now because you’re not going to be able to enjoy them for long.
But the economy doesn’t appear to be cooperating. January’s jobs market report was very strong. Employers outside the big tech companies are still in hiring mode.
Economic prospects might not be as vibrant as they were maybe a year or so ago, when we were pulling out of the pandemic lockdown, but they’re still pretty robust. Which means that the Fed is likely to keep rates high for a lot longer than investors believe.
Right now, the economy seems to be surviving. Despite fears that millennials and younger, less experienced, corporate chieftains wouldn’t know how to cope with interest rates that were higher than zero, that doesn’t seem to be the case. Corporate earnings are still pretty strong. Bond defaults are minimal.
So there’s little pressure on the Fed to start lowering interest rates, even as a humanitarian gesture.
Except maybe from the fiscal side of the government.
It hasn’t happened yet, but look for Congress and the White House — despite their avowed reverence for Fed independence — to start ratcheting up the pressure on Fed Chair Jerome Powell to lower rates in order to help manage the ever-burgeoning federal debt load, which is only getting worse the higher and longer interest rates stay elevated, on top of all the other spending lawmakers are enacting.
For the past 20 years or so, Washington has been able to put Modern Monetary Theory — basically, the idea that government deficits and spending don’t matter — into practice because zero percent interest rates engineered by the Fed have enabled it.
But that’s not the case anymore — quite the opposite, in fact.
Higher rates paid by the U.S. Treasury on its debt are only making the deficit even worse. And sorry, folks, extending the debt ceiling isn’t going to much matter, except to once again kick the proverbial can down the road.
We’ll simply have more and more government debt incurring a higher price, which will only balloon the federal debt load at an even faster pace, even without any new spending.
As we already know, most of the federal budget—meaning Social Security, Medicare and the military establishment—have been declared off-limits from spending cuts, which doesn’t leave much else for pruning.
If Powell thought the past five years of his tenure have been pressure-packed, he hasn’t seen nothing yet.
The only way he lowers rates is with a monumental cave-in to both Washington and Wall Street, and right now he doesn’t seem likely to accommodate them.
Disclosure: This article is the opinion of the contributor themselves. The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. This contributor is not receiving compensation (other than from INO.com) for their opinion.