May 8, 2024 - Economy

How the U.S. economy adapted to 5% interest rates

Illustration of two hands holding percentage icons, one hand is higher than the other.

Illustration: Aïda Amer/Axios

One year ago this month, the Federal Reserve pushed its target interest rate above 5% — a step that seemed sure to cause ripples across the corporate landscape and the global economy. To a surprising degree, though, the world has taken the onset of 5% rates in stride.

Why it matters: After more than a decade of cheap money, the U.S. economy has adjusted to the new era of high borrowing costs — with more business leaders accepting that it could be the new normal.

  • Surely, most economists thought, something was going to break, given the speed of the move from near-zero rates to 5%+. But it hasn't.

Driving the news: Even if you hadn't been following the solid growth and hiring figures, economic optimism could be sensed this week at the Milken Institute Global Conference — the annual confab of top executives and billionaires.

  • There was even a physical reminder of the strong U.S. construction activity: A record number of attendees squeezed into a tighter space than usual at the Beverly Hilton, where a renovation was underway.
  • "Look how well-attended this conference is, and there's half a hotel here," real estate billionaire Barry Sternlicht told the crowd Tuesday, a sign of strong demand.
  • Mention of a "recession" was rare — instead, conversations in elevators and on the main stage dealt with the use cases for AI and signs of an upbeat economic outlook.

State of play: Yes, companies face more expensive borrowing costs — but many locked in longer-term debt during the ultra-low interest rate period that ended in 2022, so they have time to adjust before that debt rolls over.

  • Sure, there have been tremors in the banking system — but regulators have successfully protected depositors from the fallout, and there has been no cascade of failures.
  • The stock market has bounced to new highs, and the housing market is humming along, with the biggest problem being a lack of supply.

What they're saying: "Last year, there was this sense that the economy really couldn't withstand an interest rate shock," Jason Thomas, global head of research at Carlyle, told Axios on the sidelines of the conference.

  • "Talk of a soft landing, hard landing pervaded economic discussion. Now it has shifted generally to a more optimistic tone," he said.
  • "There is much more conviction that even if everything is not under control, it is more manageable — and in any case, this is the future, so we need to adapt to this," said Andrea Guerzoni, a global vice chair at EY.

The intrigue: During a main stage panel at the conference, one top Fed official wondered whether rates were doing enough to constrict the economy.

  • Minneapolis Fed president Neel Kashkari pointed to the booming stock market as another sign: "There's a pretty strong disposition to exuberance in financial markets, so that does give me concern," he said.
  • "Are financial markets behaving in a manner consistent with monetary policy that is tamping down demand on the economy? That's a little bit of a head-scratcher," he added.

The big picture: At the conference, many suggested that it was the ZIRP phenomenon of the 2010s that was an anomaly — not the current period of high rates.

  • "The last decade was highly abnormal," George Maris, chief investment officer at Principal Asset Management, told Axios.
  • "What we're doing now is getting to a much more normalized interest rate environment," Maris said.
  • "It feels like we are in the stages of just fine-tuning around the edges" when it comes to interest rates, said David Steinbach, global chief investment officer at Hines, one of the world's biggest real estate investors, during a panel.

The bottom line: One worry was geopolitics — and what a shift to more protectionist policies would mean for the global economy. Along with other factors, that might mean more price pressure, at least in the short term.

  • "When people talk about inflationary pressures from all the AI investment, the energy transition or deglobalization — all that means is that the interest rates necessary to keep inflation at 2% will have to be much higher," Carlyle's Thomas said.
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