Good Friday Morning! Especially to Mr. Randolph White of Williamsburg County, South Carolina, who took the internet by storm this week describing the crash landing of the US government’s missing F-35. I don’t necessarily believe the government’s explanation of how it somehow lost an entire F-35, but I do trust the witness testimony of Mr. White.
This week, I will dive deep into the latest interest rate moves by the Fed and what we can see moving forward in the economy—links to follow.
- The internet is debating whether PA. Sen. John Fetterman’s slobby dressing is bad for Senate decorum. The obvious answer is a resounding yes. But Fetterman’s incapacity to dress like a grown man is not the issue here — the real problem is that this is a man who cannot physically or mentally function unless he’s dressed like a rack of Goodwill’s rejects. And as some have pointed out, he’s wearing the same thing every day. It’s bizarre. He’s still using assisted software to talk to others, he’s incoherent in person, and it’s unclear if he’s running anything in his office. Stephen L. Miller explains this exactly right in The Spectator: “The Senatorial dress code is not the issue. The issue is the ongoing deception by John Fetterman, his family, his office and the media who will go to the lengths of bullying their own colleagues should they dare report on the accurate nature of Fetterman’s abilities.” It’s not a tinfoil hat thing to say there is an active cover-up regarding Fetterman’s mental and physical capacity to do the job. There’s an entire fake narrative about Fetterman being “bullied” right now. The whole change in the Senate dress code is about enabling one human who can’t function outside the constraints of those rules. This isn’t some blue-collar guy chafing against dress codes —Fetterman is not mentally capable of doing the job. Joe Biden is running laps around Fetterman in comparison. Think about that for a second.
- We are in the slow-motion process of hurtling towards another government shutdown. The deadline is October 1, and lawmakers are trying to figure out how to get around it. Per usual, the House Freedom Caucus on the right is bomb-throwing, pretending they’re firmly against more government spending. They’re also trying to challenge McCarthy despite having no plan for a replacement House speaker or a way to fund the government. I blame the House Freedom Caucus because this group has brought more unneeded strife to the Republican Party while not providing anything of value to budgetary restraint. Scratch that; they don’t even know how to pass a budget. Since the Obama administration, Congress has not functioned under standard budgetary rules. Furthermore, because the House Freedom Caucus is taking this stance, they will empower Democrats to take charge to get something passed so we “avert disaster.” These fights are foolish by every measure, and the Representatives leading the demand have nothing to show for over a decade of bomb-throwing on this issue. If I sound frustrated, I am. It’s the same song and dance every time. And at the end, Republicans end up like Daffy Duck, yelling “Duck Season Fire!” at the end of the argument and getting their head blown off.
Where you can find me this week
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NFL, Sports Leagues Face Certain Future of Gambling Scandals – Conservative Institute
Donald Trump – The Pro-Choice Republican – Conservative Institute
Why Disney is Likely to End Its Lawsuits Against DeSantis and Florida – Conservative Institute
Higher for Longer Becomes Higher for… Forever?
The Federal Reserve maintained interest rates this month, keeping things in the 5.25% – 5.5% zone. The most remarkable thing about the official Fed statement is that it stayed the same between when the Fed last raised rates and now paused on raising rates. The rationale for both decisions is the same.
Markets are down, though. What’s the big change? The change is that everyone on Wall Street is realizing what I’ve written for months: higher for longer really does mean higher for longer.
Greg Ip’s column in the Wall Street Journal caught my eye on this front: “Higher Interest Rates Not Just for Longer, but Maybe Forever: Rate projections suggest many Fed officials see a rising ‘neutral rate'”
It’s not just that interest rates have to stay high; it’s that we will be here for a while. And the reason people are thinking this is because the voting members of the Federal Reserve raised their forecasts for interest rates through 2024. Previously, this year, they believed as many as four rate cuts could happen in 2024. Now, they’ve backed down to two rate cuts.
I believe there won’t be any rate cuts unless we see something serious shift in the economy. Rates will go down once the Fed is convinced the underlying causes of inflation are gone or economic calamity forces rate cuts on them.
Greg Ip notes in his column that the Fed believes the neutral rate is going up: “On Wednesday, Federal Reserve officials surprised markets by signaling interest rates won’t fall as much as previously planned. The tweak might be more important than it looks. In their projections and commentary, some officials hint that rates might be higher not just for longer, but forever. In more technical terms, the so-called neutral rate, which keeps inflation and unemployment stable over time, has risen.”
What is the neutral rate?
The “neutral rate” (often referred to as the natural rate or r-star, r∗r∗) is a concept used by the Federal Reserve and other central banks. It’s the hypothetical interest rate at which the economy is neither expanding too quickly (which might cause inflation) nor contracting (leading to unemployment). When the actual interest rate is set at the neutral rate, the economy is in a balanced state, with stable inflation and full employment.
In simpler terms, think of the neutral rate as the “just right” rate. It’s the Goldilocks rate for the economy—not too hot and not too cold. The Federal Reserve considers this rate when deciding whether to raise or lower actual interest rates to steer the economy towards this balanced condition.
For the Federal Reserve, inflation and deflation are things to avoid. Setting an interest rate policy that keeps things neutral or with low inflation while allowing economic growth is ideal.
Everyone believed the neutral rate was around 2% for the longest time. Ip notes in his column:
Before the 2007-09 recession and financial crisis, economists thought the neutral rate was around 4% to 4.5%. After subtracting 2% inflation, the real neutral rate was 2% to 2.5%. In the subsequent decade, the Fed kept interest rates near zero, yet growth remained sluggish and inflation below 2%. Estimates of neutral began to drop. Fed officials’ median estimate of the longer-run fed-funds rate—their proxy for neutral—fell from 4% in 2013 to 2.5% in 2019, or 0.5% in real terms.
As of Wednesday, the median estimate was still 2.5%. But five of 18 Fed officials put it at 3% or higher, compared with just three officials in June and two last December.
That means the Federal Reserve says the low-interest rate environment of the 2000s and 2010s is over. To keep this economy in check, the Fed believes it has to maintain higher rates to keep inflation in check. That’s a significant shift in thinking from the past 25 years of near-zero interest rates.
One of the investments that best reflects this sentiment is US Treasuries. For the last few days, the yield on 10-year Treasuries has spiked as investors are factoring in much longer time horizons for higher interest rates. As Treasuries spike, so do things like mortgage rates and more. Mohamed El-Erian observed on Twitter/X, “It is likely we see 8% mortgages soon.”
The shift in markets is a reflection of a higher interest rate environment. For the last year or so, markets have bet the Federal Reserve would cut rates sooner rather than later. I’ve joked that the recession is always six months away. The same is true of rate cuts. Markets have continually bet that rate cuts are always 12 months away or less. Markets have consistently been wrong on that for two years and counting.
Aside from the fight over inflation, there are two big issues with a higher neutral rate for the federal government.
- Cost of Borrowing: An increase in the neutral rate usually suggests that the actual interest rates set by the central bank will rise (or have already risen) in response. When interest rates increase, the cost for the government to borrow money (i.e., issue new debt) also increases. This means that the interest payments on new government debt will be higher, which can increase the annual budget deficit if other factors remain constant.
- Existing Debt Servicing: For existing government debt that is at variable rates or due for rollover, the interest payments can increase when rates go up. This, again, can widen the budget deficit if not offset by other budgetary changes.
What this also means is that every CBO projection for the Federal Budget you’ve seen in the last few years is wrong. Interest payments, the rates on new debt, and more will be much higher as we move further into this decade and the next. The same is true for states – budget projections are all wrong at the moment. No federal or state prognosticator could plan for rates at these levels for this long.
Big spending plans from Congress, always popular, will have a much more complicated case in the coming years. When rates were near zero before the pandemic, the US government could afford to spend like a drunken sailor. There wasn’t an interest rate concern. Donald Trump famously called for more infrastructure spending because interest rates were so low. That’s changing rapidly now. Every CBO, Treasury, or agency projection of government debt/deficits is wrong.
There’s a similar issue for the average consumer.
- Cost of Borrowing for Consumers: As the neutral rate goes up, and if actual interest rates set by the central bank follow suit, the cost for consumers to borrow money can increase. This can mean higher interest rates on mortgages, auto loans, credit cards, and other forms of personal debt. As a result, consumers might reduce borrowing or find it more challenging to manage their existing debt.
- Consumer Spending: With higher interest costs and potentially larger monthly payments on variable-rate loans, consumers may have less disposable income. This can lead to decreased consumer spending, slowing economic growth.
- Housing Market: Higher interest rates can make mortgage loans more expensive, potentially reducing the demand for homes. This can slow down the housing market, leading to lower home prices or slower appreciation in home values.
- Business Investment: For businesses, a higher neutral rate, leading to higher actual interest rates, can increase the cost of financing for capital projects, potentially slowing down investment. Companies might delay or cancel planned projects if the expected return doesn’t exceed the higher borrowing costs.
- Business Profits: Businesses with significant debt might see an increase in their interest expenses, reducing profitability. For sectors particularly sensitive to interest rates, like real estate or capital-intensive industries, the impact might be more pronounced.
- Capital Flows and Exchange Rates: A higher interest rate in one country relative to others can attract foreign capital, leading to an appreciation of the local currency. While this can benefit consumers by making imports cheaper, it can hurt exporters as their goods and services become more expensive for foreign customers.
- Valuation of Assets: Higher interest rates generally lead to higher discount rates in valuation models. This can reduce the present value of future cash flows, possibly leading to lower valuations for stocks, real estate, and other assets.
- Bank Profitability: While higher interest rates can squeeze borrowers, they can be a boon for banks if the spread between their lending rate and the rate they pay to depositors widens. However, if higher rates lead to increased defaults, this can offset potential gains.
There’s one other issue that I’ve mentioned in the past, and it’s worth reiterating here. All the above is valid unless the Federal Reserve is forced to cut rates due to an emergency.
The most likely culprit is a recession. The Federal Reserve’s commitment to ending inflation’s grip on the economy ends in a recession that harms politicians. If we hit a recession, that changes everything. And in truth, the Fed may still think they need to trigger a recession to prevent a scenario where rates remain sky-high for an extended period.
Is it better to pop this issue now? Or wait out the problem with higher rates and increasing pressure on consumers, businesses, and governments? It’s unclear what the Federal Reserve thinks. Further, it needs to be clarified what Congress thinks. They’ve been fine letting the Fed fight inflation like this. Still, sooner or later, their constituents will complain about the expenses of higher interest rates.
The most likely culprit of a recession remains a credit crunch, which would cause even higher interest rates. It’s turtles all the way down. I don’t envy the Fed’s job here. But I also know that the rosy scenarios everyone paints right now aren’t wholly accurate because we’re still watching the impacts of the Federal Reserve’s rate hiking campaign trickle into the data.
As we head into an election year, any anger over interest rates will get hotter, too. The Fed wants the perfect landing scenario. But they may not get to control the ship for the entire descent. For now, though, higher for longer is seen as higher for forever.
Links of the week
UAW strike against Detroit 3 ready to expand as new deadline nears: What we know – Detroit Free Press
Twitter Thread(s) of the week
Satire of the week
House Democrats Threaten To Keep Government Open – Babylon Bee
5 Chunky Aran Jumpers To Hide Your Body Under Until Next June – Waterford Whispers News
Thanks for reading!