Higher Interest Rates: A Headwind or Speed Bump for the U.S. Economy?
When Higher Interest Rates Were Welcome
When I was Chief Investment Officer at Knights of Columbus, a higher-interest-rate environment was a desired condition. We had a public bond portfolio of more than $25 billion, and a 10-basis-point change in rates equated to $25 million in incremental investment earnings.
One day, while we were having lunch, I asked him if it was a sin to pray for higher interest rates. In his wonderful brogue, he furrowed his brow and asked whether I benefited. I paused and told him that the clients and company benefited, although I supposed a few bucks might end up in my bonus.
He told me that as long as I didn’t benefit first, it wasn’t a sin.
I miss my old friend, and I thought of him this morning as the 10-year Treasury yield topped 4.9%. I also thought about August 2020, when the 10-year yield fell to 0.52%. Where were these rates when I was an insurance guy?!
The Economic Effects of Higher Rates
At the same time, in present day, it got me thinking about the current rate environment, the economy and markets. Make no mistake, a 10-year Treasury yield near 5% will put 30 -year mortgage rates at or above 7%. Higher interest rates may also add pressure to inflation.
That said, the U.S. economy has been incredibly resilient, and many pundits argue that even a modest decrease in energy prices could create opportunities for further economic gains. CPI inflation is now running at approximately 3.3%—cooler than it was earlier this year, but still hotter than the Federal Reserve’s desired level. The most recent employment report also illustrates some slack in the labor market.
What Business Spending May Be Telling Us
I recently read an interesting report from Nationwide Insurance that noted a surge in capital expenditures among small businesses. These capex spends typically occur when businesses are optimistic, but the report also indicated a possible shift from catch-up spending toward investments in areas such as artificial intelligence and automation.
We will need to see whether this business spending is focused on AI and automation as companies look for ways to address labor shortages. In any event, businesses appear to recognize the need to maintain their investments. With some help from declining energy prices, and thus inflation; we may see economic expansion continue.
A Speed Bump or a Change in Trend?
Higher interest rates are undoubtedly a headwind, but the next several months should help us determine whether this is simply a speed bump or a broader change in the economic trend.
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