Here’s what
would happen to the US economy if there are no rate cuts this year
For months now, Federal Reserve officials have
maintained that before they feel comfortable lowering interest rates, they need
to see more compelling evidence showing that inflation is headed toward 2%.
That is the exact opposite of what happened with the unexpectedly high Consumer
Price Index report last month. For this reason, Fed Chair Powell made it clear
on Tuesday that interest rate cuts by the central bank are unlikely in the near
future.
In a panel discussion with Bank of Canada Governor Tiff
Macklem on Tuesday, Powell stated, “The recent data have clearly not given
us greater confidence and instead indicate that it’s likely to take longer than
expected to achieve [2% inflation].” Following his announcement that
interest rates will remain higher for an extended period of time, US markets
initially fell, and Treasury yields increased to all-time highs before
declining. The timing and quantity of rate cuts this year have been the subject of
intense attention from the White House, businesses, and markets, but the
possibility appears to be vanishing. How will the US economy fare with painfully high interest rates for
several more months? According to experts, not as well as it has so far.
Investors are relying on reductions.
When Federal Reserve officials first predicted three
rate decreases by the end of the previous year, markets hit all-time highs. It
was expected at the time that the first of such cuts would take place in March.
Investors usually like lowered rates because they lower the cost of borrowing,
which can lead to higher profits. As a result, investors have more money to
throw into the market. Then, investors pushed back their estimate for the start
of cuts to June as inflation started to stagnate ahead of last month’s policy
meeting. However, during last month’s meeting, policymakers upheld their median
projection for three rate cuts this year, which delighted investors and
resulted in multiple new records.
However, that
momentum is wearing off. After last week’s hotter-than-expected inflation data,
the Dow, S&P 500 and Nasdaq Composite have each shed around 2% of their
value. Even with the recent selloff, stock market prices still reflect the
expectation the Fed will cut later this year, said Itay Goldstein, a finance
professor at the University of Pennsylvania’s Wharton School of Business.
“There is a risk there that if the Fed doesn’t decrease rates, market prices
will decline.” That will have a spill over effect on the overarching economy, he
told CNN. That’s because stock market declines could cause firms to delay
investments or cut back on costs. For instance, Tesla announced it was slashing
10% of its workforce as shares of the electric vehicle maker have been
plummeting this year. Market declines can also make households “feel that
they’re not as rich,” he added, which can also cause them to cut corners.
Increased likelihood of a recession
Higher rates for longer have been the central bank’s
motto ever since the Fed held interest rates stable last year following 11
rises that drove rates to their highest point in more than 20 years. However,
Goldstein warned that greater suffering for individuals and companies could
result from the Fed’s decision to keep interest rates higher for longer.
Raised interest rates tend to cause people to save more
money rather than invest or spend it, which slows the economy. This hasn’t
quite been the case thus far, though, especially in light of the most recent
retail sales report, which revealed consumers are still spending despite
inflation and the highest interest rates in 20 years. He stated that if the Fed
doesn’t lower rates this year, that risk will increase.
Already, US Treasury yields have increased dramatically due to expectations
that the Fed will maintain higher interest rates. For example, following
Powell’s Tuesday speech, the yield on the 2-year Treasury temporarily rose to
5%. Mortgage rates are rising as a result of that.
According to Brian Rose, senior US economist at UBS
Global Wealth Management, higher-for-even-longer rates “will increase
borrowing costs across the economy, which is likely to have a negative impact
on consumer spending, business investment, and the housing market.”
However, not everyone believes that if the Fed doesn’t
lower rates this year, the economy’s fissures will get worse. “We believe
that the economy is robust enough to prevent recession without the need for
cuts,” stated David Mericle, head US economist at Goldman Sachs.
