Where We Stand After Two Years of Higher Interest Rates

There have been a lot of surprises in the two-plus years since the Federal Reserve began its historic interest rate increases. Continue to expect the unexpected.

In May 2022, the Fed finally realized, much too late, inflation wasn’t transient. It needed to act. In June 2022, the 12-month increase in the Consumer Price Index peaked at a 40-plus year high of 8.99%.

Over the next 18 months, the Fed increased the interest rates it controls faster than it had in more than 40 years. It also began quantitative tightening, reducing the balance of securities it owns.

Stock and bond markets reacted quickly, incurring significant losses in 2022.

But economic growth continued at a solid rate, surprising many economists and investors who expected a recession by now. Corporate earnings fell for a time but returned to a growth path. The stock indexes recovered, setting a number of record highs in 2024.

Before concluding we’re going to avoid a recession, remember the historic lags between Fed policy changes and their effects on the economy.

Investment markets and the most interest-rate sensitive sectors of the economy react first. In this cycle, investment markets declined quickly, with the most speculative market sectors falling the most.

Real estate and other interest-rate sensitive sectors of the economy also tumbled.

It can take 24 months or longer for a monetary policy change to be felt throughout the economy, and labor markets tend to be among the last to feel the effects. That’s why we need to closely scrutinize data and trends.

There are some signs of slower growth, such as widely reported layoffs, especially in the technology sector, increased bankruptcies and higher delinquencies on credit cards.

Manufacturing contracted during most of the last two years. Consumer and business surveys reveal declining sentiment and optimism.

But there also are signs a recession isn’t imminent.

The reliable early warning indicators of recession I track (and report on twice yearly in the Retirement Watch Spotlight Series online seminars) have yet to give a clear reading. They’ve bounced between signaling recession and growth for a while.

We should expect more confusion and surprises, because this cycle is different from past cycles.

The growth preceding the Fed tightening wasn’t fueled by the usual increase in private sector debt. In fact, private sector balance sheets improved, thanks to government spending financed by debt that the Fed and banks purchased.

That made the private sector less vulnerable to rising interest rates. Higher rates haven’t curtailed economic activity to the extent they did in past cycles.

The pandemic stimulus still is flowing through the economy and sustains growth.

Households can continue to spend, because the labor market remains tight and compensation is increasing above the average rate of the last two decades.

Some businesses and sectors are having problems. But overall, earnings, revenue and cash flow increased. In the first quarter, companies beat estimates at a higher rate than in recent quarters. Also, fewer firms reduced their guidance for coming quarters.

Many companies announced increases in capital spending plans. If they follow through, higher capital spending should support growth.

Federal government spending remains elevated, and that spending is additional fiscal stimulus.

Commodity prices are higher after several years of weakness. Increases in commodity prices usually precede stronger growth.

A recession is not clearly out of the picture. There are some signs of weakness as mentioned earlier, and inflation appears to be settling above the Fed’s target.

But after two years of tighter monetary policy, there still are more signs of economic growth than contraction.