Unexpected Effects of the Federal Reserve’s High Interest Rates

The US Federal Reserve has kept interest rates at 5.5% for over a year, and during this time, the American economy has started to slow down, revealing some unexpected impacts.

On the one hand, high-income families are benefiting from the booming stock market and rising house prices. Companies are borrowing money at a fast pace, and consumers continue to spend.

On the other hand, Americans are taking longer to find jobs, and the unemployment rate has slightly increased. Small businesses are feeling the pain of rising loan costs, while low-income families are falling behind on car loans and credit card payments.

Looking at the US economy, there are both sunny and shadowed sides. Here are the different manifestations of the US economy.

The impact of interest rate hikes on the real estate market is most noticeable. The Fed’s rate hike policy not only spikes borrowing costs but also stimulates rising house prices.

The measure of housing affordability has reached its lowest level in over thirty years.

According to data from the National Association of Realtors, with mortgage rates hovering around 7%, the median monthly mortgage payment for homeowners has surged from $1,205 three years ago to $2,291 in May 2024.

For those who bought homes during the pandemic with low mortgage rates, facing the current high rates and elevated home prices, they are reluctant to sell or trade up. This leads to limited housing supply and drives prices to new heights.

Higher rates typically affect the stock market by slowing down business investments and growth. However, investors have little worry this time as US stock prices (related to many Americans’ retirement funds) have soared to new highs.

Since the Fed began raising rates in March 2022, the S&P 500 index has risen by 25%, adding about $3 trillion to household wealth.

Facing soaring rates, the job market has shown signs of cooling down after over a year.

Recruitment activities have slowed down from the overheated levels two years ago, with fewer job openings posted by companies. The number of Americans quitting their jobs has decreased, and the unemployed are finding it more challenging to secure new employment.

According to Glassdoor’s Chief Economist, Aaron Terrazas, as of June, the number of long-term unemployed has risen to 1.5 million, the highest level since 2017 except for a brief spike during the pandemic.

Long-term unemployed individuals refer to those who have been out of work for 27 weeks or longer.

He mentioned that recruitment efforts are now more focused on industries like healthcare, social assistance, and government, indicating a slowdown in other sectors. Other industries are more susceptible to the effects of economic slowing.

Despite the high loan rates, consumers continue to spend and purchase big-ticket items like cars, driving steady growth in the US economy.

On Thursday, the Commerce Department released preliminary estimates showing that the annualized GDP growth rate for the second quarter was 2.8%, well above the previous 1.4% and exceeding economists’ estimates of 2.1%. Economic growth was mainly fueled by continued consumer spending.

Based on various economic indicators, the US economy continues to perform well even with high rates while inflation has eased. However, many ordinary people are feeling discontent with the much higher prices of groceries, cars, and properties compared to a few years ago.

Wealthy families and retirees can cushion inflation with income from bond investments and savings accounts. But many households, especially low-income families coping with rising living costs through loans, are feeling the pressure of increased borrowing costs.

Fed data shows that credit card rates rose to 22.76% in May, the second-highest level since 1994. In the first quarter, the proportion of credit card balances overdue by 60 days reached 2.6%, the highest level recorded by the Philadelphia Fed since 2012.

Mark Zandi, Chief Economist at Moody’s Analytics, told Bloomberg that spending by low-income families only accounts for 15% of total consumer spending, but if this group struggles, the economy cannot prosper.

High rates haven’t hindered large corporations from borrowing as before. Prior to the Fed cutting rates, long-term investors like pension funds and insurance companies were seeking to lock in high-yield investments, aiming to attract these long-term investors.

The situation is vastly different for small businesses. According to Fitch Ratings’ forecast, the default rate for leveraged loans (often carrying floating rates) is expected to rise to between 5% and 5.5% this year, which would be the highest level since 2009.

Hans Mikkelsen, Managing Director of Credit Strategy at TD Securities, told Bloomberg: “The Fed’s monetary policy has brought significant pain to small businesses, causing many companies to go bankrupt.”