On Wall Street, every utterance or inflection from Jerome Powell and his fellow Federal Reserve officials is scrutinized, even to the extent of being analyzed with computer natural-language processors by major banks.
On Main Street, not so much. A Pew Research survey in 2014 found that about half of respondents had no idea who headed the U.S. central bank, while only a quarter could correctly name the then-Fed head, Janet Yellen, who is now Treasury secretary. Some 17% said the central bank was still chaired by Alan Greenspan, whose tenure had ended about eight years earlier.
Maybe that disparity in knowledge can be explained by the respective impact on Wall Street and Main Street of interest rates, the primary tool wielded by the Fed to tame inflation. The 5.25-percentage-point increase in the Fed’s key policy interest rate has rippled through the economy, but economic growth has substantially exceeded most forecasts.
If the Atlanta Fed’s GDPNow estimate of the fourth-quarter annual growth rate of gross domestic product proves to be on the mark, the average quarterly rise for all of 2023 will come in at 2.8%, a full percentage point above the Congressional Budget Office’s estimate of the U.S. economy’s underlying potential growth rate, according to Mizuho Securities economists Steven Ricchiuto and Alex Pelle.
That Main Street is less concerned about what the Fed says and does might be because the economy is less sensitive to interest rates than in the past. Moody’s Analytics chief economist, Mark Zandi, notes that households have a relatively low share of debt with adjustable rates, which has tempered the impact of higher rates on how much of their after-tax income goes toward interest and principal payments (see chart).
In a Nov. 21 client note, Jefferies economist Thomas Simons cited a New York Fed study that found roughly half of U.S. homeowners took advantage of low mortgage rates during the pandemic, either by refinancing or purchasing a home. Moreover, only 60% of homes in America have a mortgage, and 90% of those have rates of 4% or lower.
In many other countries, such as the United Kingdom, Canada, Australia, and New Zealand, mortgage rates generally adjust every few years. Thus, the impact of central-bank rate hikes flows directly to households, which have to boost their monthly mortgage payments. Higher mortgage rates in the U.S. thwart would-be buyers but leave homeowners unscathed.
The resiliency of the U.S. economy means the Fed’s rate hikes aren’t as aggressive as they appear, Zandi wrote on X, formerly known as Twitter. In a follow-up interview, he admitted to having been perplexed that the Fed’s rate hikes hadn’t slowed growth more acutely. But now, having observed how the economy’s relationship to interest rates had changed, he sees the central bank’s current target range of 5.25%-5.50% as making more sense.
So far, home prices and stocks have held up despite the Fed’s hikes, Zandi noted. The former reflects the long-term shortage of affordable housing, worsened by the reluctance of homeowners who have locked down those ultralow mortgages to sell. Meanwhile, excitement about artificial intelligence has pushed stocks upward.
While higher interest rates haven’t thwarted the AI-powered advance in the Magnificent Seven stocks that have lifted the
S&P 500 index
18% so far this year, they typically are a headwind for stocks. When the S&P 500 is in an uptrend and yields are falling, annual returns are 14.5%. That’s according to a chart covering the past six decades from Mensur Pocinci, head of technical analysis at Julius Baer, the Swiss bank (and posted by Jim Bianco, the eponym of Bianco Research). When the S&P 500 is an uptrend but yields are rising, however, annual returns are just 0.79%.
Although the economy remains resilient in the face of higher interest rates—if not terribly high historically—the Fed is apt to be wary about the damage it might do to stocks. “The Fed is not going to sacrifice household faith in the equity market on the altar of 2% inflation,” the central bank’s putative price target, said Steven Blitz, chief U.S. economist at TS Lombard.
In a note on Tuesday after the release of minutes of the Federal Open Market Committee meeting that concluded on Nov. 1, he pointed out that households’ exposure to the stock market is back to its highest level since 2008, according to a Gallup poll.
“They are attuned to downside risks and fear them,” Blitz wrote about the members of the policy-setting panel. If not, why would they sit and wait while continuing to characterize inflation as “unacceptably high?” he asked.
So, while the U.S. economy thus far has been relatively unscathed by the Fed’s interest-rate hikes, the stock market could prove to be more vulnerable. Recall that the S&P 500’s 10% rally since late October largely has been spurred by the drop in bond yields, which has been based on the expectation that the Fed is done hiking and is set to cut rates a full point in four increments in 2024.
But if those optimistic expectations for monetary easing fail to be realized and Wall Street falters, Main Street could begin to pay more attention to the Fed.
Write to Randall W. Forsyth at [email protected]
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