Chart of the month: US rates – how insensitive is insensitive?

In late 2021 and early 2022 we outlined why we believed that the US economy would be likely to be less sensitive to rate hikes in this cycle. This has clearly been the case, with growth still strong despite higher rates. But that doesn’t mean that the US is rates insensitive. After all, we’ve just witnessed the most aggressive hiking cycle since the early 1980s and long-term mortgage rates have risen from below 3% to over 8%, leading to the worst housing affordability in a generation.

That said, as the chart shows, the actual rate currently being paid by most mortgage holders is far lower, with the majority on very long-term fixed rate deals.

However, we believe there are still several consequences of high market rates. For instance, refinancing activity should fall to near zero and significantly impact mortgage equity withdrawal, which is a source of credit for consumer spending. In addition, higher interest rates directly reduce demand for consumer credit and auto loans, as well as making student loans more expensive. Higher interest rates can also impact the willingness of business to borrow as the hurdle rate for investment returns rises.

Higher financing costs are the dominant channel on growth from monetary tightening, and growth is normally driven by the marginal new borrower. It is now very expensive in expected real terms to borrow. Taken together, we continue to believe that the US is likely to enter recession in 2024.