There is a major gap opening up between the mean and the median of long-term inflation expectations, which means that half of the population has long-term inflation expectations that are dramatically higher than the other half, see charts below and in this chart book. This is a very significant challenge for the Fed because it cannot cut interest rates when inflation expectations are out of control.
Since the Fed started talking about rate cuts, households have turned more and more positive on equities, see chart below.
While the Fed’s rate hikes have reigned in growth, especially among over-levered consumers, corporates, and banks, the easing of financial conditions since the “Fed pivot” in December continues to offset the effect of higher rates. Through the remainder of 2024, we expect above-consensus economic growth. Inflation will remain above the Fed’s target and interest rates will remain higher for longer.
We published our consolidated views in my newest white paper, 2024 Mid-Year Outlook: An Unstable Economic Equilibrium. You can download it here.
I will also be discussing the contents of the paper and my views in detail in an Apollo Academy class today, June 20, at 11:00 ET (eligible for a CE credit). Register here.
While the Fed’s rate hikes have reined in growth, especially among over-levered consumers, corporates, and banks, the easing of financial conditions since the “Fed pivot” in December continues to offset the effect of higher rates. For the rest of 2024, we expect economic growth to be higher than consensus and inflation to stay above the Fed’s target. We see no Fed cuts in 2024.
Key Takeaways
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When the Fed raises interest rates, money market funds pay a higher dividend to households. The chart below shows that this effect is very significant and currently running at $500 billion, or around 2.5% of consumer spending. Put differently, Fed hikes are boosting consumer spending through higher money market fund dividends.
Our updated banking sector chart book is available here.
The foreign-born labor force has grown 11% since February 2020, and the native-born labor force has remained unchanged over the same period, see chart below.
The Fed’s pivot from hawkish to dovish and associated easing in financial conditions have boosted expectations for US consumer spending, see chart below.
A key reason why the economy is still so strong is the significant tailwind to growth coming from the CHIPS Act, the Inflation Reduction Act, and the Infrastructure Act.
Monetary policy is using high interest rates trying to slow the economy down. Fiscal policy is utilizing open-ended policies to boost growth and employment.
In short, the positive effects of fiscal policy are dominating the negative effects of Fed hikes, see chart below.
Before the pandemic, the share of outstanding mortgages with interest rates below 4% was 38%. Today it is 63%, see chart below.
In other words, housing is adjusting very slowly to Fed hikes. Millions of households still benefit from having locked-in low mortgage rates during the pandemic.
Put differently, the transmission mechanism of monetary policy is much slower than normal, and the Fed will need to keep interest rates higher for longer to get inflation under control.
