On September 27th, Caixin News Agency reported that prior to this month's Federal Reserve interest rate meeting, Nick Timiraos, known as the "New Federal Reserve News Agency," published several "suggestive" articles that quickly shifted the market direction towards a 50 basis point interest rate cut. However, the Federal Reserve ultimately did not disappoint people - the first interest rate cut marked the beginning of this round of easing cycle.
In a sense, Timiraos' article seems to have caught the market's attention more than the statements of Wall Street giants and even some Federal Reserve officials. On Friday morning Beijing time, this figure who can stir up the turbulence in the US interest rate market published a latest column article titled 'Cutting interest rates does not guarantee a soft landing'. And the latest signal it has released seems to have been "clearly revealed"
Timiraos wrote that whether the Fed's interest rate cuts will help achieve an economic soft landing depends only in part on the degree of weakness in the US economy. The success or failure will actually depend on the downward trend of borrowing costs, whether it can stimulate new investment and expenditure to offset the impact of economic slowdown.
He believes that achieving a soft landing that lowers the inflation rate to the Federal Reserve's target without significantly worsening the labor market is still quite challenging, as this ultimately requires new loans to restore growth. In the past year, the growth rate of bank loans has almost stagnated, which is not common during non recession periods.
Even with a slight decrease in interest rates, many businesses and households may still be unwilling to borrow because they are currently facing interest rates that are still higher than the fixed rates locked in a few years ago. If these borrowers or companies are unwilling to obtain new loans, then the boost to the economy from interest rate cuts may be minimal
Timiraos said that the key to the problem actually lies in the difference between the marginal cost of debt (currently decreasing) and the average debt interest rate (which may still rise), especially for borrowers who locked in low interest rates before the Federal Reserve began raising interest rates. Due to the Federal Reserve's rapid interest rate hikes after borrowing costs were historically low for over a decade, the average debt interest rates in many industries are still below the marginal cost of new credit, even though the Fed is currently cutting interest rates.
Timiraos cited Peter Berezin, Chief Global Strategist at BCA Research, stating that the easing effect of the Federal Reserve's interest rate cuts on the economy is not significant, as even if the Fed starts cutting rates, the average interest rates faced by households and businesses will still rise.
Demand does not recover as quickly under interest rate cuts
Timiraos explained this using the housing market as an example.
He said that the weak housing demand in the past year actually illustrates how borrowers are doing their best to avoid accepting higher interest rates - in this case, they are no longer moving (not buying a new house).
According to data from Freddie Mac, in the mortgage market, the 30-year fixed rate loan interest rate fell below 6.1% last week, the lowest level in two years and significantly lower than May's 7.2%. But according to the loan data of the Intercontinental Exchange, the average outstanding mortgage interest rate in July was 3.9% - because many Americans hold long-term fixed rate mortgages, the interest rate has hardly changed in the past two years.
In addition, so far, the decrease in interest rates has not had much promoting effect on housing affordability, which is still at historically poor levels. Jody Kahn, Senior Vice President of John Burns Research and Consulting, said, "Loose policies have not created a clear surge in demand. A recent survey of 50 residential builders showed a slight increase in internet traffic, but overall, opinions vary on whether internet traffic is rising due to a decrease in mortgage rates
Currently, most Federal Reserve officials expect to cut interest rates by another 50 basis points by the end of this year, on top of last week's 50 basis point rate cut, thereby pushing the target range for the federal funds rate back to between 4.25% and 4.5%.
However, for debt due next year, even if the Federal Reserve cuts interest rates by 100 basis points within the year, corporate borrowers who originally had lower fixed rate loans may still face significant increases in borrowing costs.
The impact of conduction lag cannot be ignored
Timiraos pointed out that it is certain that investors are currently optimistic because the Federal Reserve still has a lot of room for interest rate cuts. Lower interest rates will boost market sentiment, including their expectation that if the weakness becomes apparent, the Federal Reserve will accelerate action to alleviate the predicament. In addition, some smaller, high-risk companies with floating rate debt and bank loans can immediately enjoy the breathing space brought by the Federal Reserve's interest rate cuts. The Federal Reserve's interest rate cut may also weaken the US dollar, allowing emerging market economies to relax interest rates without worrying about their own currencies weakening.
However, Timiraos also mentioned that the current easing cycle may face challenges similar to the Fed's recent rate hike cycle - that is, the transmission mechanism to the economy may not be smooth. Two years ago, when the Federal Reserve raised interest rates at a massive pace of 75 basis points, analysts were amazed at how the economy unexpectedly withstood higher monetary costs.
It has been proven that many households and businesses are able to maintain resilience because they locked in low fixed term borrowing costs in 2020 and 2021, when interest rates fell to ultra-low levels.
Former Kansas City Fed President George said, "The tightening cycle of interest rates has encountered the fact that we have just provided cash buffers for many companies and households, which means they no longer need to borrow, and this has indeed hindered the transmission of (tightening) policies. Whether the same thing will happen during the (interest rate) downturn is still unknown
Jon Faust, who served as Powell's senior advisor from 2018 until the beginning of this year, stated that central bank governors must acknowledge that their understanding of how monetary policy is transmitted to the broader economy is very limited. We already have a clear understanding of the direction, so when you haven't exerted enough force yet, you should exert more force. The specific situation of 'when' and 'how big' (interest rate cuts) does depend on the economy, and to a large extent, it depends on things we cannot control
Some business owners are currently cautious about last week's interest rate cuts. Compass Diversified CEO Elias Sabo said that even if we cut interest rates by a full percentage point, it won't have much effect because we are still at a relatively low level of interest rates. Sabo pointed out that the company has seen a sustained decline in consumer demand over the past year, with a noticeable decline between the first and second quarters and a less noticeable weakness entering the third quarter.
Ted Friedman, a commercial real estate lawyer in Cincinnati, said that few industries can better illustrate this dynamic than real estate. Many homeowners with much lower interest rate debt are currently waiting until the last minute to refinancing, hoping that the Federal Reserve's interest rate cuts will be even greater by then. Friedman pointed out that the balance sheets of many regional banks are very saturated, with many challenging assets on them, which makes lenders cautious about refinancing borrowers who have not become customers.
He predicts that unless there is a significant interest rate cut in the next year, the loan default rate will steadily rise, as homeowners cannot extend their loans to maturity without investing more assets. He said that the performance of these assets currently looks quite good, but there will be trouble when they need to be extended.