In the past two years, the rapid increase in benchmark interest rates has risen by 525 basis points, the fastest level since the 1980s. The more important question for investors to consider is whether the degree of Federal Reserve tightening is sufficient.
By pushing up financing costs through policy interest rates, we can determine the degree of crowding out of incremental financing demand and erosion of stock interest costs.
The purpose of monetary tightening is to suppress demand, mainly by raising policy interest rates to guide the overall financing costs of society to rise, thereby affecting new demand and stock costs:
1) financing costs are higher than investment returns, suppressing incremental financing demand;
2) stock interest pressure increases, squeezing out other consumption and expenditures.
The transmission of monetary tightening to credit tightening is not smooth, mainly for three reasons:
1) the broad investment return rate is higher than the financing cost, making the decline in incremental demand slow;
2) high interest rates have limited transmission pressure on locked-in stock interest, and have not significantly eroded consumption and expenditure;
3) government credit is not completely dominated by the above economic and cost factors. For example, in the second quarter of this year, due to the resolution of the debt ceiling and the "forced" expansion of bank risk exposure, it offset the contraction of the private sector and became the "source" of economic acceleration in the third quarter.
Lets take sectors.
Household sector
mainly mortgages, with fixed-rate loans accounting for more than 90%; current effective interest rates and household interest payment pressures are low. Household credit is mainly for mortgages (as of the end of 2022, US resident mortgages accounted for 72% and consumer loans accounted for 28%).
Although the 30-year mortgage rate has exceeded 8% in late October, the absolute dominance of fixed-rate loans accounts for 94% as of the end of the second quarter. Therefore, actual interest costs are not affected by the rise in interest rates.
Result: The 8% mortgage rate has exceeded the real estate return rate; existing home sales and mortgage growth continue to decline.
Corporate sector
Fixed-rate corporate bonds account for 80%, and floating-rate loans account for more than 50% for small business credit; current effective interest rates are high, especially for small businesses, and interest payment pressures are the highest since 2018.
The proportion of fixed-rate loans in current stock corporate bonds is 78%, but the floating-rate part of small business stock commercial loans that rely more on bank loans accounts for 53%. As of the end of September, the effective interest rate of investment-grade bonds in the United States has risen to 8.4%.
Result: The high-yield bond rate has approached the investment return rate, and the overall loan cost has exceeded it; corporate bond issuance has shrunk for two consecutive quarters, and industrial and commercial loan growth has turned negative.
Government sector
The main part of the existing US Treasury bonds is medium-to-long term, with low effective interest rates and relatively high interest payment pressure; however, leverage is not completely constrained by this. The existing national debt is mainly medium-to-long term (accounting for 70%), but the impact of interest rate increases is mainly reflected in short-term national debt, floating rate national debt, and some maturing medium-to-long term national debt.
This means that the increase in the effective interest rate of government debt lags behind the Fed's rate hikes, and the current effective interest rate has risen from 1.57% in February 2022 to 2.91%.
Result: The condition for solving the debt ceiling issue in early June this year is the limitation on discretionary spending limits for fiscal years 2024 and 2025, which is difficult to further expand.
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