July 2024 Newsletter: Rates Insensitivity in the Downcycle

Item #1: Fiscal Deficits

U.S. fiscal deficits were huge in 2020 and 2021, but contracted in 2022 as most of the emergency programs dwindled.

However, by 2023, fiscal deficits began rising again , mainly due to increased interest expense. This is where fiscal dominance became rather sustained: the Fed’s interest rate hikes, which were meant to slow

Whenever mortgage rates drop to new lower-lows, homeowners have a big incentive to refinance their mortgage rates. Paying off a previous 6% mortgage with a new 4.5% mortgage can free up a lot of disposable income each month, and without increasing a homeowner’s overall debt load. And then, years later, paying off that 4.5% mortgage with a newer 3%

Globally, during this cycle:

-China has had strong industrial production, but weak consumer spending.

-Europe has been relatively weak both in industrial production and consumer spending.

-The United States has been strong in consumer spending, but relatively weak in industrial production.

Putting Them Together

The United States is running larger fiscal deficits than most other countries, and its private sector has a higher proportion of long term fixed rate debt than most other countries. This means that in an interest rate hiking cycle, the United States has been rather de-sensitized to rising rates compared to other countries tha

There’s no single best way to quantify it, but if I had to point to one set of charts, I would say that fiscal dominance occurs when annual public deficits exceed the sum of annual net bank lending and annual net corporate bond issuance on a sustained basis, especially without having been caused by a recession.

Item #2: Fixed Consumer and Corporate Rates

Homeowners and investment-grade corporations termed out their debt a lot longer than the federal government has. Many homeowners have locked in 30-year mortgages. Many corporations have average corporate bond durations of ten, twenty, or thirty years as well. As interest rates rise, these homeowners and

Relatedly, when fiscal deficits as a share of GDP are rising during a period of falling unemployment over a sustained period of time, that is another sign of fiscal dominance. This type of breakdown in correlation has occurred rarely within the past 70 years: