"The Federal Reserve's Megaphone": Low interest rates do not guarantee a soft landing for the United States

Nick Timiraos, a Wall Street Journal reporter known as the "mouthpiece of the Federal Reserve," said that whether the Fed's rate cut can achieve an economic soft landing depends not only on how much weakness exists in the U.S. economy internally, but also on whether lower borrowing costs can stimulate new investments and spending to offset any economic slowdown.

Fed Chairman Powell's move to cut rates by 50 basis points last week was seen as a "show of strength," as he reiterated the Fed's desire to avoid having to make larger rate cuts in the future in the event of economic weakness. "We don't think we're behind the curve," Powell said at a press conference. "You can see this as a signal of our commitment not to fall behind."

Achieving an economic soft landing, which involves lowering the inflation rate to the Fed's target level of 2% without significantly deteriorating the labor market, may still be tricky because it ultimately requires new loan growth. Over the past year, bank loan growth has slowed to a "crawl," a phenomenon that typically only occurs during economic recessions.

Even with some decline in interest rates, many businesses and households may still be reluctant to borrow as they would face higher rates than their current fixed-rate loans (which were locked in several years ago). If these borrowers or businesses are unwilling to take on new loans, rate cuts may have little effect on boosting the economy.

Timiraos pointed out that the issue lies in the difference between marginal debt costs (currently decreasing) and average debt rates, which may continue to rise, especially for borrowers who locked in low rates before the Fed began raising rates. Due to the Fed's rapid rate hikes after unprecedented low borrowing costs for over a decade, the average debt rates in many industries are still lower than the new credit marginal costs, even as the Fed is cutting rates.

Peter Berezin, Chief Global Strategist at BCA Research, stated, "The easing impact of rate cuts on the economy is not significant, as even with Fed rate cuts, the average rates faced by households and businesses will rise."

Is the Demand Surging or Trickling?

Over the past year, soft housing demand indicates that borrowers are doing everything possible to avoid accepting higher rates. During this rate hike cycle, they are choosing not to move.

According to data from Freddie Mac, last week the interest rate for a 30-year fixed-rate mortgage in the U.S. fell to below 6.1%, the lowest level in two years, up from 7.2% in May. However, according to data from the Intercontinental Exchange on loan levels, the average outstanding mortgage rate in July was 3.9%. Since many Americans have long-term fixed-rate mortgages, this rate has remained almost unchanged over the past two years.

Furthermore, Timiraos noted that so far, rate cuts have not effectively boosted Americans' housing affordability, which is at historically low levels. "Loose policies have not led to a significant surge in demand," said Jody Kahn, Senior Vice President at John Burns Real Estate Consulting. A recent survey of 50 homebuilders showed a slight increase in website traffic, "but overall, there is a very mixed sentiment on whether website traffic has increased due to the decline in mortgage rates." Last week, the Federal Reserve cut its short-term benchmark interest rate by 50 basis points to a range of 4.75% to 5%. Most officials expect another 50 basis point cut by the end of December, which would bring the benchmark rate to a range of 4.25% to 4.5%.

For debt maturing in the next year, even with a full percentage point cut in rates by the Fed this year, corporate borrowers with lower fixed-rate loans may still face a significant increase in borrowing costs. Rebecca Patterson, former Chief Investment Strategist at Bridgewater Associates, said that companies with long-term fixed debt "don't need to do anything right now, so they won't change their decision-making activities in the short term."

Timiraos said, it is certain that investors are optimistic because the Fed has a lot of room to cut rates. Lower rates will boost market sentiment, including signaling that the Fed will act more quickly to cushion the economy in the event of a slowdown.

Furthermore, some smaller and riskier companies (with floating-rate debt and bank loans) will immediately benefit from the Fed's rate cut. More importantly, a decline in U.S. rates could weaken the dollar, allowing emerging market economies to cut rates without worrying about currency depreciation.

Risks for the Federal Reserve

Timiraos believes that the Fed faces a risk that the current easing cycle may face challenges similar to the recent tightening cycle in terms of transmission to the broader economy. Two years ago, when the Fed raised rates by 75 basis points, analysts were increasingly surprised by the remarkable resilience of the economy to higher funding costs.

It turns out that many households and businesses have resilience as they locked in low borrowing costs with fixed terms as rates fell to extremely low levels in 2020 and 2021.

Former Kansas City Fed President George said, "The tightening cycle encountered the fact that we provided a lot of cash cushion to many companies and households, which means they don't need to borrow, which does weaken the transmission of policy." She said whether "this will also happen during the rate cut process" is an unknown.

Jon Faust, who served as a senior advisor to Powell from 2018 to earlier this year, pointed out that central bank officials must accept the fact that they know little about how monetary policy transmits to the broader economy. He said, "The specific details of 'when' and 'how much' actually depend on the economy, and this largely depends on things we cannot control."

Some business owners are cautious about last week's rate cut. Elias Sabo, CEO of Compass Diversified, said that even with a full percentage point cut, "it won't have much effect because we are still coming down from fairly high rate levels." The company is a private equity firm that owns medium-sized businesses Sabo stated that the company has seen sustained weak consumer demand over the past year, with a significant decline between the first and second quarters, followed by some easing in the third quarter.

"Wherever you operate, everyone is seeing this situation," Sabo said. At the beginning of the year, vacancies at his company reflected the difficulty of recruiting qualified candidates. Now, he said, his company is slowing down the pace of recruitment and intentionally keeping positions unfilled as demand has cooled.

Few industries illustrate this dynamic better than real estate. During the COVID-19 pandemic, the United States transitioned from a historically low interest rate period to an ultra-low interest rate period, and then quickly shifted to the highest interest rate period in twenty years, which is particularly confusing for the commercial real estate industry. "There was a lot of buying and selling activity at the time, while on the other hand, there was a sharp slowdown," said Cincinnati commercial real estate lawyer Tedd Friedman.

Many property owners with low-rate debt are waiting until the last minute to refinance, hoping that the Federal Reserve will significantly cut interest rates by then. Friedman noted that many regional banks have "fairly robust balance sheets with a lot of challenging assets on the balance sheet," making lending institutions reluctant to refinance for non-existing clients.

He expects that unless interest rates are significantly lowered in the coming year, loan default rates will steadily rise as the refinancing costs for property owners will increase by then. "The performance of these assets is quite good until refinancing is needed," he said