In a stark warning, Altaf Kassam, State Street’s head of investment strategy, has predicted a potential economic storm if the U.S. Federal Reserve fails to act swiftly on interest rates.
Broken Mechanism: Interest Rates with Delayed Impact
Kassam asserts that traditional monetary policy levers, which have guided the economy for decades, have essentially “broken.” This means that any adjustments made by the Fed will take longer to filter into the real economy, potentially delaying any major shocks.
The Insulation Factor: Long-Term Mortgages and Refinancing
Two factors have largely insulated both consumers and businesses from the current higher interest rates. Firstly, many homeowners locked in low-interest, fixed-rate mortgages during the COVID-19 era. Similarly, corporations seized the opportunity to refinance their debts at advantageous rates.
As a result, the impact of sustained higher interest rates may not be felt immediately, but rather when these mortgages and debts come up for renewal. Kassam warns that if rates remain elevated until 2025, when a significant wave of refinancing is due, the shockwaves could be severe.
Fading Hopes for Rate Cuts
Initial expectations of Fed rate cuts in the near future have waned due to persistent signs of inflation and hawkish statements from policymakers. San Francisco Fed President Mary Daly recently declared there was “no urgency” to reduce rates given the economy’s strength and above-target inflation.
Kassam confirms that State Street maintains its view that the Fed will still make a rate cut in June. However, he acknowledges that sentiment among the broader market has shifted, with several banks projecting only a single rate cut in December, if at all.
European Bank Divide
The European Central Bank, however, appears to be on a slightly different trajectory. Despite holding steady in its recent meeting, the ECB remains widely anticipated to lower rates in June. However, Morgan Stanley has trimmed its expectations for ECB rate cuts in 2024, citing the changing outlook for Fed policy.
Kassam’s warning serves as a reminder that the U.S. economy faces potential turbulence if the Fed does not navigate the interest rate landscape effectively. The breaking of traditional monetary policy mechanisms introduces a layer of uncertainty that could have far-reaching consequences.
Data sourced from: cnbc.com
