What's the impact of action-less Fed's statements on borrowers
The statement that came out yesterday from the US Fed was quite a dampener for stock markets. Yesterday, before the statement came out, S&P futures were staging a strong bounce. However, all did not end well.
The candle yesterday ended as an inverted hammer and today's candle makes the picture look bleaker. The Fed signaled on two major points yesterday and below are some key points -
With inflation well above 2 percent and a strong labor market, the Committee expects it will soon be appropriate to raise the target range for the federal funds rate
I think there’s quite a bit of room to raise interest rates without threatening the labor market
What the above means for the markets is that there will be a rate hike in March and many more during the year (4! is what the market is expecting). The Fed also indicated that quantitative easing will stop by March and Balance Sheet reduction will also begin progressively.
The above statements are hawkish as hell! However, what impact have these statements from the past had on borrowers so far? The Fed hasn't acted as of now. We need to look at a few charts first -
Let's think about Corporate Borrowers. US 5-year and 10-year government bonds, the base rates for more 5-year and 10-year corporate borrowings have shot up 1% and 0.5% in absolute terms respectively. DXY has strengthened by over 6% and therefore corporate profits are facing the hit from that (think about Netflix). The first two charts show the impact on corporate bonds - HYG: High Yield (or Junk) bonds; LQD: Investment Grade Bonds. Both have been decimated in the last couple of months. Borrowing costs have gone up for borrowers that issued record debt in the last 2 years. Refinancing this debt has just gotten more expensive. I wouldn't be surprised if bond funds also start recording massive redemptions, given the current Fedspeak.
What about retail borrowers. A simple look at 30-year mortgage rates in the US will help us a lot.
From 2.8%, 30-year mortgage rates in the US are headed to 3.8%. For a home that costs $500k, monthly installments just went up from $2,000 to $2,200 if one gave a 20% deposit. If one has taken a fixed-rate mortgage, then all is good. However, for those who were tempted by low rates of adjustable-rate mortgages, next year will be painful. (Average home price in the US is $420,000 and average personal income is $37,000. Household income can be considered twice as that and take-home pay can be worked out)
Consumer debt hit a record in the US in December 2021! Source. Most of this is variable rate revolving debt i.e. Credit card debt. Other forms of major loans are student loans and auto loans. Buying cars just became more expensive. When higher installments eat away from disposable income, things can get pretty bad pretty quickly. It impacts corporate profits and then leads to layoffs. This can be the start of a vicious circle.
Is this trend that the Fed is willing to initiate, sustainable? ABSOLUTELY NOT! The Fed knows this and therefore it is next to impossible for US Fed to raise rates 4 times a year and make any significant moves of balance sheet reduction. Talk is easy, action is difficult. Sure, there will be one rate hike, maybe 2. However, how long is it possible for the Fed to exhibit its false bravado? Not for long.
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