Jul 29, 2023 - Economy

Why the U.S. economy is so immune to rate hikes

Illustration of Uncle Sam wearing sunglasses and wearing a hat with stripes forming upward arrows.

Illustration: Shoshana Gordon/Axios

The U.S. economy continues on its glide path to the elusive "soft landing," even in the face of 11 rate hikes and counting. That's in large part because we spent the 15 years before the rate hikes steadily deleveraging and ensuring that debtors couldn't easily fall victim to a credit crunch.

Why it matters: Rate hikes in many other countries, especially the UK, hurt most of the population very rapidly, thanks to their high homeownership rate and how short-term their mortgages are.

Be smart: The U.S. has positioned itself to be able to withstand rate shocks much more easily.

  • Household and corporate debt is mostly fixed-rate rather than floating-rate, meaning that debt payments don't immediately rise when rates go up.
  • There's also less debt, overall, than there has been historically (more on that below) — a surprising fact, given that more than a decade of zero interest rates gave many businesses a strong incentive to borrow a lot of money.

How it works: Rate hikes have an effect in two ways: By raising the cost of debt for existing borrowers, and by discouraging new borrowing.

  • U.S. rate hikes are definitely doing the latter. With mortgage rates back above 7%, and house prices back up near all-time highs, buying a home is more expensive than ever. That's one reason home sales are down, hurting the industries that rely on such things (sofa makers, realtors, etc.)
  • Corporations, on the other hand, seem to be borrowing as much as ever, just at higher rates.
  • The big exception is the least creditworthy companies — the ones rated as high-yield, or junk. They are borrowing less, borrowing for shorter time periods, and putting up collateral to lower their borrowing costs.

Between the lines: The loan market is generally floating-rate, which means that companies that have issued loans rather than bonds are now feeling the pinch.

  • The two industries with the highest degree of leverage are finance and commercial real estate. Rising rates brought down Silicon Valley Bank and other banks; they're also causing real estate bankruptcies to rise, as building owners find it impossible to refinance their mortgages at an affordable rate.
  • Outside those rate-sensitive industries, however, higher interest rates have caused relatively little pain.
  • Meanwhile, savers are receiving interest rates on their money that they could barely have dreamed of a year ago.

The bottom line: The good news is that the U.S. economy has shown that it can remain strong — certainly thus far — in the face of an ultra-aggressive rate-hiking cycle by the Fed.

  • The bad news, at least for borrowers, is that rates might have to remain high for some time before the Fed feels comfortable bringing them back down to a more neutral level.

The U.S. deleveraging, in four charts:

U.S. corporations had debt-to-equity ratios above 100% as recently as the final quarter of 2019. Now that number has fallen to 82%.

Data: Federal Reserve via FRED; Chart: Axios Visuals
Data: Federal Reserve via FRED; Chart: Axios Visuals

U.S. household debt, similarly, has come down from more than 100% of GDP in 2008 to just 76%.

Data: IMF via FRED; Chart: Axios Visuals
Data: IMF via FRED; Chart: Axios Visuals

The amount households are paying to service their debt is also down. It was over 13% of disposable income in 2008; it's now 9.6%. The Fed hikes are barely visible.

Data: Federal Reserve via FRED; Chart: Axios Visuals
Data: Federal Reserve via FRED; Chart: Axios Visuals

Even highly indebted companies who fund themselves with junk bonds (as opposed to leveraged loans) aren't too worried for the time being — their debt mostly isn't coming due for years.

Data: BofA Global Research, ICE Data Indices LLC; Chart: Axios Visuals
Data: BofA Global Research, ICE Data Indices LLC; Chart: Axios Visuals
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