Why does a higher interest rate solve the problem of inflation? In the past the primary objective was to make borrowing costs high enough to dissuade home buyers and consumer debt holders from continuing this practice. This presents an interesting dilemma, in my opinion, because since the inflation crisis of the early 1980’s there has been a steady decline in the level of the average 30y mortgage rate that even during the financial crisis in 2009 kept the average mortgage at between 6% and 4.5%. This is noteworthy to me as a homeowner during that time when I refinanced my mortgage rate that began at over 9% in the early 1990’s. The drop is meaningful, especially since the value of a traditional 30yr mortgage holders debt saves approximately $100 for every 1% increase or decline in the prevailing rate. Not exactly much to write home about. When it comes to consumer debt, Consumer debt payments as a percentage of disposable income has also seen a steady decline also since the early 1980’s, reaching it’s low in 2021. This could be because of two reasons, the first is the greater financial discipline brought on by the spike in interest rates in the 1980’s and second is the painfully high interest rates we’ve all experienced using traditional credit cards, rates that have had little to do with federally managed interest rates. Worth noting however has been the unsurprising increase in the past two years probably the result of the growing increase in online spending but also because of the increases stemming from the pandemic. But even that could be offset by the spike seen in the annual personal savings rate of consumers that also occurred during the pandemic.
So, what is the current narrative? The current narrative suggests that investors and savers will more likely move to taking advantage of the increases in income that can be earned from short term investments. The logic, if consumers aren’t spending their money on their pleasures, then inflation will have nowhere to go but down. I have to admit I’m a touch skeptical of that premise since the stock market has given savers opportunity to invest and receive income at much higher rate levels than the current interest rate markets provide and maybe some profit as well. And there is a natural resistance to growing costs, for most people some can’t spend it, won’t spend it or can afford to spend it. Anyway, we look at it, as it’s going to be a problem for the economy only if it gets too high and even current predictions see the average trend around 2.3% in 2022, relative to the 30yr Breakeven Rate of 2.38%. And even if there is a brief stretch over the next few quarters, it could support those who still see the rise as ephemeral, a different word same meaning, of the word we’re not supposed to use anymore according to Mr. Powell.