The Fed may keep interest rates at high levels for longer, which may not be as bad as the market thinks

The current overall resilience of the U.S. economy is evident, despite some recent pullbacks in the U.S. stock market, the overall performance remains quite good. It is hard to convince people that high interest rates have had a substantial negative impact on the U.S. economy.

With the recent uptick in U.S. inflation over the past few months— inflation at the 3% level is sticky, significantly higher than the Federal Reserve's 2% target, which has led to a retreat in rate cut prospects. The immediate question is: what if the Federal Reserve decides to maintain interest rates at the current level for a longer period, even throughout 2024? What if the Federal Reserve does not cut rates next, but instead raises them once or twice? How will these actions by the Federal Reserve impact the financial markets and the broader economy?

Looking back to the beginning of this year, investors did not anticipate the above questions. At least at this stage, the scenario of "sustained high interest rates" has made Wall Street and market participants uneasy. Because the market generally believes that from a pricing perspective, if interest rates rise, adjustments must be made, and the situation changes.

Industry insiders point out that close attention should be paid to the information conveyed during the current earnings season, as answers to some questions will soon be revealed. Company executives will provide important details beyond revenue and profit, including the impact of interest rates on profit margins and consumer behavior. If there are any signs that companies have to start cutting costs, leading to issues in the labor market, then this will be a sign that high interest rates may cause problems.

Looking back in history, high interest rates do not necessarily mean bad things for the U.S. stock market and the economy, and may even be a good sign. High interest rates leading to economic recession is not logical. Generally speaking, as long as high interest rates are related to economic growth, it is not a bad thing. Of course, this is not absolute. The last time this was not the case was when then-Fed Chairman Volcker used aggressive rate hikes to curb inflation, ultimately intentionally causing the U.S. economy to fall into recession.

During periods of strong economic growth, such as the current one, the Federal Reserve rarely cuts rates. This week, the U.S. will release GDP data for the first quarter of 2024, with market expectations at an annualized 2.4%. If so, this will mark the seventh consecutive quarter of U.S. growth exceeding 2%.

Conversely, keeping interest rates too low for too long is more likely to lead to crises. For example, it gave rise to the dot-com bubble and the subprime crisis. Before the outbreak of the COVID-19 pandemic, the Federal Reserve's federal funds rate was only 1%. In other words, the recent major economic recessions were actually crises planted during periods of low interest rates.

Some economists believe that the impact of Federal Reserve policy on the U.S. economy has been exaggerated. Their evidence includes: in the more than ten years before the outbreak of the COVID-19 pandemic, the Federal Reserve tried to raise the inflation rate to 2% through monetary policy, but largely failed. In other words, the Federal Reserve's monetary policy mainly affects the demand side, which remains strong, while the supply side is largely beyond the control of interest rate policy, and this is actually the main driving force behind the slowdown in inflation Based on the above reasons, after the outbreak of the COVID-19 pandemic, inflation in the United States soared and then fell back. The decline coincided with the tightening monetary policy of the Federal Reserve, leading some economists to question how much the Fed truly contributed to this.

The real impact of interest rate policy is in the financial markets, which in turn affect the economic situation. Interest rates that are too high or too low can distort financial markets. In the long run, this can ultimately damage the economy's productive capacity and may lead to bubbles, thereby destabilizing the economy.

Some industry insiders point out that the current interest rate level in the United States is too high for the financial markets. The Fed should gradually restore interest rates to a normal level that is neither very low nor very high, and maintain it at that level.

Currently, the market does not consider the Fed's neutral rate of 2.6% to be realistic, which is a rate that neither stimulates nor restricts the economy. Goldman Sachs recently suggested that the neutral rate could be as high as 3.5%. Loretta Mester, President of the Federal Reserve Bank of Cleveland, also indicated that the long-term neutral rate could be even higher.

Therefore, although the market generally expects the Fed to cut interest rates sooner or later, it is unlikely to return to the near-zero interest rate levels seen after the financial crisis. In fact, looking back over time, the average level of the federal funds rate since 1954 has been 4.6%, including the nearly seven-year period of near-zero rates after the 2008 financial crisis.

Furthermore, many economists mention that the reason the Fed's tightening policy did not have a serious impact on the U.S. economy is partly due to the large-scale government spending in the U.S. offsetting the Fed's rate hikes. However, the surge in U.S. national debt, coupled with rising interest rates, has led to a surge in the U.S. government's net interest payments.

Since the outbreak of the COVID-19 pandemic in March 2020, U.S. national debt has soared to $34.6 trillion, an increase of nearly 50%. It is expected that in the 2024 fiscal year, the U.S. federal government's budget deficit will reach $2 trillion, and net interest payments will exceed $800 billion. In 2023, the U.S. government's deficit as a percentage of GDP will be 6.2%, compared to the European Union's limit of 3% for its member countries