Higher For Longer

The Credit Strategist - May 2024

It is becoming increasingly clear that higher interest rates are not the problem for stocks that many expected. There are several reasons for this, the primary one being the massive fiscal stimulus that boosted economic activity. Unfortunately, the sticky inflation that is a byproduct of this stimulus (while boosting corporate profits and stock prices) may be starting to suppress consumer spending if recent results from MCD, SBUX and other companies are any indication. Whether this regime of massive deficits will prove to be sustainable remains to be seen because it depends on generating massive amounts of public and private sector debt that can only be resolved through default, inflation and/or currency devaluation. But for the moment the economy and stock market are benefitting from the government spending beyond its means.  

After its April meeting, the Federal Reserve made it clear that it is relatively comfortable with its current policy stance and has no plans to change course until much later this year.  It is comfortable enough that it decided to start shrinking its quantitative tightening program by reducing the monthly decline in its Treasury holdings from $60 billion to $25 billion (leaving in place a $35 billion monthly reduction in its mortgage-backed securities holdings). The Fed appears to be heading to a place where it will maintain a much larger balance sheet in the future than in earlier periods, further evidence that fiscal and monetary policy are closely aligned in a world of mega-deficits.  Some observers viewed Fed Chairman Powell’s comments in the post-meeting press conference as dovish but he seemed to make it clear that the Fed still views inflation as too high to justify a rate cut.  The central bank remains under pressure because of the rising cost of servicing the federal deficit so at some point it will probably have to lower rates even if inflation doesn’t hit two percent and figure out how to justify such a move and retain its credibility.

April’s job report was viewed as weak by the markets and sent them rallying on the belief (hope) that it would make the Fed more inclined to lower rates sooner rather than later.  Leaving aside the question of how higher stock prices factor into the Fed’s thinking, the market was likely overreacting (as it typically does) to one month’s data.  As noted in footnote 1, the report confirmed what we already know – job growth is supported by government spending of which there is no end in sight.  The fact that job growth is weighted to the public sector is better than no jobs growth but as The Wall Street Journal’s editorial page points out, “jobs that rely on transfer payments from government aren’t the kind of investment-based jobs that will create new products or productivity gains that add to national wealth.” Unfortunately, a great deal of the remaining jobs growth is supported by private sector borrowing because the private sector depend so heavily on debt rather than equity financing.  The result is diminishing economic productivity in a system devoting increasingly large portions of its financial and intellectual capital to government transfer and public and private sector debt payments.