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What a Rise in Interest Rates Really Means

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By Jim Woods

So as we all embark on this potentially steep rate hike, I wanted to take a minute to see what effect the rate hike has had on “the real economy” because one of the biggest risks to the market right now is an economic downturn – and understanding when rates are reaching a level where that could happen is very important.

To see what effect rising interest rates have on the economy, we looked at the rates of several major consumer loans: 30-year mortgages, 5/1 variable rate mortgages (ARMs), 60-month auto loans, credit HELOCs), and credit card debt.

And the conclusion for all of these loans was clear: rates are not yet at levels that we believe will limit growth (and in some cases are still far from levels that would limit growth).

With the exception of the 30-year mortgage (which is arguably the largest of these consumer loans), none of the other major consumer loans are significantly above levels seen in January 2021, when growth economy and inflation were both more subdued.

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5/1 ARM, HELOC, auto loan, and credit card rates are all essentially where they were in January 2021, and in all of these cases they are below January 2020 levels (prior to the pandemic), a time when consumer balance sheets were not as strong as they are now.

Today, mortgage rates have risen and are above pre-pandemic levels. But they’re still well below January 2019 levels, and that’s remarkable because early to mid-2019 was the last time we saw a significant loss of economic momentum, prompting the Fed to suspend balance sheet reduction and rate hikes in mid-2019.

In the end, while Treasury yields rose, leading to an acceleration in mortgage rates, the majority of other important consumer loan rates did not rise substantially.

So what does this mean for financial markets?

We and others have always said that Fed rate hikes eventually stifle economic growth, but how many hikes and how long they take depends on (1) how low rates are initially and (2) the strength of growth when rates start to rise.

At the moment, the “take-off” in rates is starting very low and economic growth remains very strong, and this analysis of consumer loans reinforces this point: it will take time for the Fed to stifle the economic recovery, even if it raises rates 50 basis points at the next meeting of the Federal Open Market Committee (FOMC) in May.

Ultimately, interest rates are rising and they will continue to become an increasingly strong headwind for the economy and the markets. However, they are not yet close to levels that would imply stagnant economic growth. That’s why, despite the many risks facing the markets, we’re sticking to equity allocations, as we may still have a year (or more) of economic expansion ahead of us (although that may be too optimistic , but we will monitor and, of course, let you know if anything changes).

For now, the risk of stagflation (ie high inflation and stagnant economic growth) remains a future, not imminent, problem.

Originally published on MoneyShow.com

Editor’s note: The summary bullet points for this article were chosen by the Seeking Alpha editors.