SOMETIMES PEOPLE ARE VERY INSENSITIVE

I'm tired of talking about the Federal Reserve (Fed). The truth is it has been a key player in our economy for the past four years and has a heavy hand in its future. Ignoring the Fed is not a choice.

The Fed is our country's central bank and has two mandates: achieve maximum employment and keep prices (inflation) stable. One of its main tools is its ability to control short term interest rates. Historically, interest rates and economic activity move in opposite directions. So in 2022 when the Fed significantly raised interest rates, pretty much everyone (including myself) expected an economic slowdown. It never happened. Why didn't things go according to plan? I believe the economic turmoil of COVID shutdowns, massive stimulus, and high inflation created long-lasting and very unpredictible distruptions in the way things work. We're still living in the wake of all that mess.

Here's how things normally work. People and companies who borrow money typically spend that money right away. For example, you take out a car loan and go buy a car. When interest rates go up, people either don't want to or don't qualify to borrow as much money. This leads to less borrowing, less spending, and an economic slowdown, but in 2023 there was no slowdown. Consumers and companies were insensitive to higher rates, so the Fed's rate hikes had little impact. What changed?

In 2020 when COVID hit, many companies rushed to borrow whatever they could at rates that were rock bottom thanks to the Fed. By August 2020, the Fed pushed interest rates so low that a 10-year government bond only paid 0.4% (not a typo). When 2023 rolled around, companies didn't really care what the Fed was doing with rates. Many had plentiful cash from their 2020 borrowing binge and weren't looking to borrow more. Consumers also proved to be insensitive to Fed rate hikes. In 2020 many people used stimulus money to pay down debt and beef up savings. When 2023 rolled around, many middle income households were in great financial shape. They didn't need to borrow more to sustain their spending. Some spent out of their beefed up savings. Others had ample overhead on their credit card limits to keep charging new purchases, so the Fed raised rates and everybody shrugged.

This year the Fed is talking about possibly cutting interest rates. Given consumers current insensitivity, will this have any real impact on borrowing and spending patterns? Unless the Fed has some big cuts in store, I don't anticipate much reaction. A while back I noted big economic disruptions have big economic consequences. A better statement would be big disruptions have big and unpredictable  consequences. Until we get beyond the wake of COVID disruptions, I predict more unpredictability.

Frank Rizzo, CERTIFIED FINANCIAL PLANNER ^TM

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