The two most discussed topics in the market recently are: first, why does it seem like the interest rate hike has little impact on the US economy, and second, why is the US stock market performing much better than expected? Even Wall Street’s leading bearish strategist is doubting himself and changing his tune.
In fact, these two topics are somewhat related, so we will discuss them together. Many people say that the US economy typically slows down 6-12 months after the Fed raises interest rates. However, the Fed kicked off the rate hike last March, while the US economy is still showing no signs of slowing down in the first half of this year, with actual GDP growth of 2% and 2.1% year-on-year in the first and second quarters, respectively. This has surprised many.
It is estimated that the US government injected a large amount of money into the economy during the pandemic to ensure stability, and much of this money is still in banks. So, despite the high interest rates, people still have money to spend and buy stocks, supporting the US economy and stock market. The ratio of bank deposits to GDP in the US was about 64% at the end of April, slightly higher than the 60% that had been maintained for many years before the pandemic but lower than the peak of 77%. At the current pace, it is estimated that bank deposits will not return to pre-pandemic levels until the end of this year, indicating that the impact of the interest rate hike on consumer spending may not be reflected until the end of this year or early next year.
Second, for more than a decade, global interest rates have been kept low for a long time, and many companies have seen that interest rates are approaching zero, so they took the opportunity to convert their debt into fixed-rate long-term bonds. So even though the federal funds rate has increased by 5%, most companies’ interest burdens do not seem to have been greatly affected for the time being. Of course, many small and medium-sized companies may calculate their loans based on floating interest rates, especially those who finance through private credit. However, the lack of transparency makes it difficult to assess risks. If we use the high-yield bond market, which is similar in size to the private credit market, as a reference to gauge, the default rate for US high-yield bonds may rise to 4.5-5% by the end of this year from about 1.9% as of this May, according to data from Fitch Ratings.
Third, although the US government has reduced its fiscal deficit this year compared to the pandemic period, it is still relatively high compared to normal years. Part of the reason is the increase in interest rates, and part is due to President Joe Biden’s $2 trillion investment package, which plans to allocate funds to infrastructure upgrades, inflation reduction, semiconductor production, and research, among other things, over the next ten years. These long-term economic stimulus plans have also contributed to the government’s deficit rate rising.
As a result, when individual consumption, businesses, and the government have not yet truly felt the impact of the interest rate hike, how can the economy slow down?
But what about the future? There are two noteworthy changes. First, as mentioned earlier, there is a possibility that the ratio of bank deposits to GDP will return to pre-pandemic levels by the end of this year. The second change is that student loan repayments, which were put on hold, are set to resume in October this year. Currently, there are 37 million student loan borrowers in the US who have benefited from deferred repayments, with a total monthly repayment of approximately $10 billion. For reference, Americans spend about $35 billion a month on clothing and department stores. While $10 billion may not be a substantial amount, it will impact consumption.
There is a saying in the market that when even the last bear turns bullish, it indicates that the market is not far from its peak. Is Wall Street’s leading bearish strategist, who recently turned bullish, the last one?
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