Sour and sweet rate hikes: Why the Fed has a "Lemonhead" problem
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The Fed has a Lemonhead problem. That's the term that one investor is using to explain why the central bank's historic rate-hiking campaign hasn't done more damage to the economy (yet).
How it works: Like the candy, rate hikes start off sour — the S&P fell 19% last year; the tech industry shed a lot of jobs. But then they turn sweet — that's where we are now, with consumer spending and the labor market still looking relatively solid.
- "The full effect of higher rates is not being felt by consumers and businesses," said James Fishback, founder and chief investment officer (and candy theorist) at Azoria Partners, a global macro hedge fund.
Zoom in: Two key players in the economy have so far been relatively insulated from higher rates: mortgage holders (i.e., a lot of consumer households) and companies with fixed-rate bonds (think Apple or Microsoft).
- A slew of companies took advantage of the very low rates of 2021 and are now benefiting from the higher rates they can earn on cash.
- 82% of mortgaged homeowners have a rate below 5%. Many refinanced during a wave two years ago and locked in rates of 3% or less. Plus, the value of their homes has soared — a factor that may lead some to feel wealthier and spend more.
Like homeowners, many companies took advantage of low rates back in 2021. They borrowed money — by issuing bonds — and locked in low rates for long durations.
- Companies don't borrow on 30-year timelines like homeowners, but the average duration for investment-grade corporate debt has doubled from four to eight years, Fishback pointed out.
- And companies are paying less in debt now than a year ago. U.S. corporate net interest payments have fallen for the past five quarters, according to Bureau of Economic Analysis data. At the same time, businesses are earning 4%-5% on their cash holdings.
- Many companies have "actually benefited from higher rates," Fishback wrote in an email.
What's next: Eventually, as one continues to savor the Lemonhead, it turns from sweet back to sour. ("I got, like, a case of them," Fishback said.)
For the record: David Einhorn, Fishback's former boss at Greenlight Capital, coined a jelly donut hypothesis to argue that rate cuts were hurting the economy.
- The idea was the first rate hike, like the first donut you eat, is delicious or effective — but the yum factor, or effectiveness, decreases with each subsequent treat or rate cut.
Bottom line: Those donuts are still with us today, shielding mortgage holders and business owners from the full power of historic rate hikes.
