by Zain Jaffer
Fed Chairman Jerome Powell’s early March 2023 briefing to the US Senate and House Banking and Finance Committees stated that inflation is still running strong. He said that until inflation goes down to the 2% level and that price stability is achieved, interest rates still need to be raised further from the more than four percent total from last year. [1] This brings further negative impacts to the stock, housing, and other markets. Paradoxically, the low unemployment is the one contributing to the inflation, thus seeing higher unemployment is the sign that will trigger the Fed to stop hikes.
Already the stock markets are on edge. This is especially true for stocks that are discretionary, like tech and automobile stocks whose products can have their purchases pushed out for better times.
Crypto also relies on excess liquidity in the system, and thus gets negatively affected by higher rates. Car purchases, especially those that are done with higher interest car loans, have decreased. Instead, used car markets like Carvana are the ones that benefit.
Housing already has less demand, given that fewer people want to sign up for higher interest long term mortgages. Although construction has picked up and somewhat eased the sudden halt in new houses built during the pandemic, the decrease in home mortgage takers has created only a few home buyers. [2]
Commercial real estate has a slightly different problem. Less people wanting to go back physically to offices and preferring instead to work from home as much as they can do not bode well for office buildings. Occupancy of most offices is low, and it is likely that some of those will be converted to condominiums or apartments if that is feasible. The problem is, instead of dealing with a corporate tenant leasing one or several floors of office space, the new tenant is just paying for one small residential unit. So in that respect commercial real estate, particularly office spaces, is facing deep trouble unless it can reinvent itself or a new renaissance in workin at the office happens. Those scenarios are not likely for the near term.
Savings for many families have long been depleted by the pandemic. The post pandemic economic recovery that happened is being potentially derailed by a possible recession later this year or in a few months, if we are not already in it. Many are living on credit, for which many are having problems meeting their monthly payments.
If interest rates are raised further, expect more defaults. If they get laid off from work, again expect more defaults. Many who are employed now will lose their jobs.
For government bonds, a phenomenon called Yield Curve Inversion started to happen when the Fed started hiking rates. This meant that the yields of short-term treasuries began to be higher than long term government bonds. Many people now prefer to just hold cash short term in these treasuries as opposed to buying the longer term ones. Also for similar types of bonds such as the ten-year bond, the current bonds yield more than older ten-year bonds bought during the low interest rate years. This is what caused the Silicon Valley Bank (SVB) bank run. Their money was heavily invested in ten-year bonds that only yielded 1.79% versus the current 3.9%. As they needed to cash out pre-maturity to service withdrawals from clients, they got hit with a $1.8bn mark to market accounting loss.[3]
Although the advice to tighten belts might be obvious, if everyone does this too much then indeed the recession will happen. Only the businesses that rely on really core needs like food, housing (rent), clothing, and energy would remain afloat. Discretionary spending based businesses would suffer greatly.
Powell isn’t really aiming for deflation. He is only aiming for price stability. While it is expected that demand for goods and services will drop, if it drops too much then the opposite problem of no one buying anything rears its head. That’s both deflation (price decreases over time because of no demand) and a recession where GDP keeps decreasing.Then businesses will just shrivel up and die because everyone has overtightened their belts.
The way to affect a soft landing is for everyone to remember the balance between over tightening your spending and remembering that every dollar spent goes around and makes the economy go round.
NOTES
[1] Federal Reserve Chair Jerome Powell appears before Senate panel amid inflation concerns | full video – YouTube
[2] https://www.reuters.com/markets/us/us-mortgage-interest-rates-jump-highest-level-since-november-mba-2023-02-22/
[3] https://www.theguardian.com/us-news/2023/mar/10/silicon-valley-bank-collapse-explainer