top of page
  • Writer's pictureThomas Hayes

Why Higher Interest Rates Haven’t Caused a Consumer Slowdown

In 2020, as a global pandemic gripped the world economy, the Federal Reserve cut the federal funds rate to a target range of 0%-.25% in an effort to provide relief for businesses and stimulate the economy. In 2021, after inflation exploded to its highest level since the early 1980’s, the Fed decided it might be time to change course. So, in early 2022, they embarked on the fastest interest rate hike campaign in modern history, with the goal of slowing the economy, and in doing so, stemming rising inflation. In a little over one year, the Fed funds rate rose from a range of 0%-.25% up to 5.25%-5.5% today. The chart below shows just how historically fast the Fed raised rates. So why haven’t these higher rates had more of an impact on the economy and consumer spending?

Fixed Rate Mortgages

One major reason this rate hike campaign has been ineffective at slowing down the consumer, is the percentage of low interest, fixed rate debt that individuals and businesses were able to obtain in 2020 and 2021. Mortgage rates fell to an all time low during this time, and 91% of borrowers were able to lock in mortgage rates below 5%, with 70% of borrowers locked in below 4% according to data from Morningstar. The reason this is such a big deal is that mortgage payments make up roughly 70% of all consumer debt payments.[2] With the majority of consumer debt at a low fixed rate, higher interest rates have had a minimal impact on household budgets. In fact, according to data from Moody’s, the share of all household debt that adjusts with interest is just above 10%, it’s lowest level in the past 40 years. As a result, interest rates have had little impact on consumer balance sheets, allowing spending to remain strong.

Labor Market and Rising Wages

The labor market has also remained strong, with unemployment near an all-time low at 3.5%. As a result of decreased immigration during the pandemic, accelerated retirements, and 1.1million deaths in the U.S., employers are having trouble finding workers to fill job openings. As a result, consumer spending has likely remained strong as it is largely tied to employment. In short, if people have wages coming in, they aren’t likely to change their spending habits. The tight labor market has resulted in meaningful wage gains as well, with income for earners in the bottom decile seeing the largest increase in decades from 2019-2022. [4] ( This dynamic of low-rate fixed consumer debt, and real wage growth, has caused household debt payments as a percentage of disposable income to fall the lowest level in over 40 years as well.[5]

Corporate Balance Sheets

Corporations also benefited from the low interest rate environment in 2020 and 2021, as they were able to issue bonds at historically low rates. In 2020 corporations issued a record $2 trillion investment grade corporate bonds, up 53.7% from 2019, while high yield bonds saw a 30% increase at $570 billion.[6] Many corporations increased the duration of these bonds beyond prior norms, and locked in their borrowing costs at historically low rates for longer periods than they had in the past.

So Where Do We Go From Here?

If rates continue to rise, it will be interesting to see the effect it has on consumers. At a certain point, the large number of corporate bonds issued in 2020 will come due, and potentially need to be rolled over at higher rates. When that happens, cash strapped corporations may need to reduce expenses, potentially in the form of employee reductions. This has already shown up for many profitless companies starting in 2022. As their borrowing costs soared in the higher interest rate environment, they scrambled to reduce expenditures. Even so, the job cuts in many cases were short lived, and concentrated to particular sectors such as technology. This was largely due to the fact that consumer spending buoyed corporate earnings beyond expectations, supported by strong consumer balance sheets. With so much consumer debt locked in at low fixed rates, the question of what it will take to eventually slow consumer spending remains. It is likely unemployment will need to rise in order for consumers to see a meaningful impact on their balance sheet. However, on what timeline that occurs remains an unanswered question.

Disclaimer: The opinions voiced in this article are for general information only and are not intended to provide specific advice or recommendations for any individual. To determine which strategies or investments may be suitable for you, consult the appropriate qualified professional prior to making a decision.

22 views0 comments


bottom of page