February 22, 2024

The Federal Reserve’s rate hikes are no match for the American consumer

As the Rockettes worked their way to the record box office for the annual “Christmas Spectacular” at New York’s Radio City Music Hall, they did more than just entertain.

They also showed the limits of the Federal Reserve’s power over the economy.

If the Fed’s post-pandemic rate hikes had worked as they have in the past, Americans would have responded by cutting back on spending. Instead, the economy has advanced virtually unscathed.

Demand for Rockettes tickets was so high that the dance troupe added eight additional shows to the schedule, extending the Christmas specials until the first week of January. More than 1 million customers saw the holiday performances.

Elsewhere, companies like Hilton, Ford and Chipotle benefited as consumers and businesses opened their wallets. Despite the fastest rate increases in four decades, the economy is hotter today than when the Fed first raised borrowing costs in March 2022. The 353,000 jobs created last month were the highest monthly total since January 2023.

“Even though the Fed is raising rates, people aren’t feeling it,” said Nathan Sheets, chief global economist at Citigroup.

The strong growth has calmed fears of a recession and could lead the Fed to delay its long-awaited move to cut rates.

The rising growth of the US economy and falling inflation put an end to fears of a recession

When the Fed fights inflation, it typically raises interest rates to discourage consumers and businesses from borrowing money. Fewer personal and business loans translate into lower demand for all kinds of goods, which slows the economy and takes pressure off prices.

That was the idea when the Fed started raising rates two years ago as U.S. inflation approached levels not seen since the early 1980s. The Fed’s interest rate rose from near zero in less than 18 months to its current level of above 5 percent.

But the results were unexpected.

Rising interest rates tend to increase the value of the dollar, widening the trade deficit as foreign products become more affordable while U.S. exports suffer, said economist Dean Baker of the Center for Economic and Policy Research.

This time, however, many other central banks raised their interest rates to combat inflation. The dollar therefore did not experience a sustained increase. And the trade deficit narrowed rather than widened as consumers stopped buying imports and started spending more on personal services like movies and dining out.

The last time the Fed raised rates sharply, beginning in the spring of 2004, the economy slowed from growth of around 3 percent to growth of less than 1 percent two years later.

Today’s economy has been able to shake off higher interest rates, in part because of the extraordinary period of very low borrowing costs that followed the 2008 financial crisis.

Adjusted for inflation, credit was free most of the time between 2008 and 2022. That era of easy money allowed many consumers and businesses to refinance their debt and lock in ultra-low interest rates, Sheets said.

In the latest wave of home mortgage refinancing, 14 million Americans “have benefited from historically low interest rates and will enjoy low borrowing costs for decades to come,” the Federal Reserve Bank of New York said last year.

As a share of disposable income, debt service payments are no higher than they were when the Fed began raising rates and are still slightly lower than on the eve of the pandemic.

Many consumers and businesses today are less sensitive to higher rates than in the past, thanks in part to the legacy of the pandemic.

For much of the past few years, millions of consumers have had more cash than usual. Trapped at home and supported by government stimulus programs, Americans set aside money. Excess liquid assets peaked at an estimated $1.5 trillion in early 2022, according to Eric Winograd, director of developed market economics research at AllianceBernstein.

The overburdened supply chains that caused major headaches during the pandemic also had a silver lining: Spending on products like cars was spread out over a longer period, economists said.

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Americans who couldn’t find a car to buy in 2021 or 2022 eventually did so. And by the time cars hit dealer lots, many buyers were willing to pay higher prices. A total of 16.6 million vehicles were sold in December, compared to just 14 million two years earlier.

“The economy has outperformed the most optimistic expectations despite this tightening cycle,” Winograd said. “But almost all that excess savings has been processed. That pillow is no longer there.”

As these temporary factors subside, higher interest rates may eventually take hold. Higher interest rates are causing some companies to “reassess future projects and contribute to softer business investment and hiring,” according to the minutes of the Fed’s December meeting. Small businesses faced tighter credit.

The percentage of auto loans that were 90 days late just rose above pre-pandemic levels. Delinquent credit card balances are also higher than in 2019, according to the New York Fed.

This complex portrait of an economy that is growing rapidly despite rising interest rates but still showing signs of stress puts pressure on the Fed to find the right time for its first rate cut, expected as early as May.

Fed Chairman Jerome H. Powell said in late January that higher interest rates are having an effect on the economy, especially through the housing market. The Fed’s rate hikes reduce demand by making credit more expensive. New home sales fell in the second half of last year as 30-year mortgage rates approached 8 percent.

But Powell acknowledged that other factors outside the Fed’s control — such as improved supply chain performance and the return of more Americans to the labor market — are also driving down inflation.

They also effectively protect parts of the economy from the full force of tighter credit. But as companies iron out the latest problems in their freight operations and the available workforce stops growing, supply-side gains will fade and interest rate hikes will take a greater toll.

“The restriction is likely to become more apparent,” Powell said.

In residential construction, which is generally more sensitive to interest rate increases, The supply chain problems also effectively expanded some activity, supporting the economy, Baker said.

The number of new homes has fallen by almost 20 percent from the level of 1.8 million in April 2022. But the number of homes under construction, which typically declines during construction, has remained stable at around 1.7 million. Homes are taking longer to build because of delays in obtaining the necessary materials, Baker said.

The good news is that as a result of these problems, residential construction employment remains at its highest level since September 2007.

That may be starting to change.

Home builder PulteGroup expects to be able to build new homes at about the same rate by the end of this year as before the pandemic. The company told analysts last week that its operations were returning to a “predictable schedule,” thanks to more reliable supplies of construction materials.

“We were literally waiting for material to come out,” said Ryan Marshall, CEO of PulteGroup.

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Many economists had expected unemployment to rise before inflation came under control. In June 2022, Lawrence Summers, a former Treasury secretary, said the unemployment rate would have to reach 6 percent and stay there for five years before consumer prices would calm down.

Instead, the unemployment rate has barely budged: it was 3.6 percent when the Fed started raising rates and it is now 3.7 percent. In each of the past three months, the number of Americans finding a new job was higher than in the previous month.

The labor market is supported by the gradual return of consumer spending to pre-pandemic patterns. After spending on products like furniture, televisions and clothing, consumers are now spending more money on travel, entertainment and other personal experiences.

Hilton Hotels served a record number of guests last year and added 24,000 new rooms in the last three months of 2023, the highest quarterly total ever. The hotel chain’s revenue per available room, a standard benchmark for the sector, rose by almost 13 percent.

“Demand is very strong,” Hilton Worldwide CEO Christopher J. Nassetta told investors last week. “The consumer, especially our consumer, in terms of our average income level, is pretty good. It is between $140,000 and $150,000, they still have enough money and a lot of desire to travel.”

Such spending on travel, leisure and hospitality is roughly three times as labor-intensive as the goods-producing industries, according to Sheets. Chipotle Mexican Grill, for example, plans to hire 19,000 new employees for its busy spring season. JPMorgan Chase also said it had 3,500 job openings as part of a planned expansion of its retail branch network.

Spending on personal services keeps the labor market tight, which means higher wages. According to the Department of Labor, inflation-adjusted hourly wages for manufacturing and non-supervisory workers increased 1 percent over the past year. Those fatter salaries ensure that Americans have the disposable income to continue spending money on trips to New York.

Madison Square Garden Entertainment, which owns the Rockettes, told investors it plans to take advantage of strong demand by raising ticket prices for their next Christmas performance. Tickets for the 2023 show started at $49.

MSG also reported a “strong double-digit increase” in the number of tickets sold for the music concerts it will stage over the next six months.

Entertainers such as Billy Joel, Nicki Minaj and Justin Timberlake will perform at the Garden. Tickets for these performances start at around $200 and can exceed $4,800 for floor seating, according to the MSG website.

“We are very pleased with how this year is shaping up,” said Ari Danes, senior vice president for investor relations. “The company is clearly growing faster than we initially expected.”

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