MacroResearchBoard

Higher For Longer – October 2, 2023

A just-published report addressed the major global investment issues, particularly last week’s surge in DM government bond yields. It is gradually sinking in with bond investors that DM central banks have not completed the tightening cycle, and rate-cut expectations for next year were far premature, and thus have been unwinding.

The resilience of the U.S. economy in the face of an historically large increase in policy rates and bond yields has caught many investors (and the Fed!) off-guard. However, the transmission mechanism whereby higher rates slows the economy has been significantly muted this cycle because borrowers were able to lock in record low interest rates in recent years. To this end, household debt servicing burdens are still extremely low relative to recent decades.

In time, higher borrowing rates will bite, especially for new borrowers. However, before this becomes a significant issue in the deleveraged U.S. and euro area household sectors, it likely will cause serious problems in the weak-link economies, especially those where lending is based on floating or short-term fixed rates, such as in Canada and the U.K.

Net: U.S. consumers still have solid balance sheets and income statements, and consumption will remain well supported. Barring some major global shock, the Fed will need to keep rates higher-for-longer in order to weaken the economy sufficiently to lower underlying inflation to 2%.