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There is so much confusion in the financial markets, as well as with consumers, over what comes next and little history to compare because we are recovering from a world-wide pandemic, the first one since the Spanish flu pandemic of the 1920s.
So, it is useful to look at interest rates as an indicator of what is normal, namely the Fed Funds rate that the Fed has jacked up to 5.25 percent (per above graph) and the Bank Prime Loan rate—which controls consumer spending and therefore economic growth and job formation—to determine what the U.S. economy might look like over next few years.
The Bank Prime Loan Rate which moves in tandem to the Fed Funds rate (see below FRED graph), is used by most banks to set both short-term credit card as well as longer-term installment loan interest rates for such as autos and appliances. And a high Prime Rate really puts a damper on consumers’ pocketbooks.
It is currently 8.50 percent in the second graph dating from the 1950s, up from its pandemic low of 3.25 percent, which ignited so much consumer spending and the mortgage refinance binge in 2020-21.
That is too high for any sustained growth. The Bank Prime Loan Rate fluctuated from 7.5 to 10 percent in the 1970s to 2000, as did a higher unemployment rate, before unemployment descended to its current 3 percent lows after the Great Recession (2009), and which is causing the current growth spurt.
Economic growth is accelerating again but the Fed must begin to lower their rates sooner rather than later for growth to continue.
Avoiding another recession will be the miracle of miracles if they don’t lower interest rates soon, since every recession since the 1950s (10 at last count per gray bars in graphs) was mainly caused by the Fed jacking up their Fed Funds rate and hence the Bank Prime Loan Rate to ‘tame’ inflation, which drastically slowed both spending and lending, as I said.
GDP growth expanded 2.1 percent in Q2. And just last week S&P Global Market Intelligence raised its third-quarter GDP estimate by nearly two percentage points to an annualized rate of 4 percent, citing strong retail sales data. It moved its annual estimate up slightly to a historically strong 2.3 percent.
Inflation should continue to decline overall because of the Fed’s past rate hikes, though consumer prices rose again in August to reach a 3.7% yearly rate, based on last week’s release of the monthly consumer-price index. That marked its biggest jump in 14 months, up from 3.2 percent in July and a 27-month low of 3 percent in June.
If we want to avoid a recession then history tells us th e Fed needs to drop its shorter-term rates, so that the Bank Prime Loan Rate returns to its historic norm of 5-7 percent, and its Fed Funds rate in the neighborhood of 3.75 percent, which history says consumers and businesses can tolerate for sustained growth.
But that also depends on supply chains remaining healthy. What about the Ukraine-Russian war? It doesn’t seem to be affecting food and energy prices anymore, since food prices are back to normal and even OPEC had to reduce oil production to boost the price of crude oil which means oil supplies are plentiful.
Returning to a more normally functioning economy also means the Fed must return to a more normal Fed Funds rate to avoid another recession, which hasn’t been the case in the past.
Harlan Green © 2023
Follow Harlan Green on Twitter: https://twitter.com/HarlanGreen
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