By Anirban Basu, Sage Policy Group
The economy has performed shockingly well over the past few years, growing at a faster rate than virtually anyone—myself included—expected. Despite the fastest inflation in over four decades, with year-over-year price increases peaking at more than 9% in the middle of 2022, and the resulting increase in interest rates, with the Federal Reserve ratcheting rates up to the highest level since 2007, economic expansion has continued uninterrupted.
Yes, some segments have struggled. Homebuying activity plunged because many would-be buyers, a large share of whom were locked into low fixed rate mortgages, couldn’t stomach the higher borrowing costs. While homebuilding activity held up better throughout 2022 and 2023, that momentum is waning as builders exhaust their backlog.
Despite that sectoral weakness, the U.S. consumer continues to spend, the unemployment rate remains low by historical standards, and employers keep hiring. U.S. payroll employment has now increased in each of the past 46 months, and while job growth was particularly weak in October, that was the result of temporary hurricane-related job losses and the now-resolved Boeing strike. The consensus expectation is hiring will rebound in November.
The surprisingly resilient expansion has been aided by rapid disinflation; prices are up just 2.6% over the past year. That’s still above the 2% target rate, but it’s close enough to accommodate ongoing rate cuts from the Federal Reserve.
Unfortunately, those rate cuts have yet to lead to any kind of meaningful increase in borrowing. Just as the Federal Reserve’s initial rate hikes didn’t have the intention of softening economic activity, the initial rate reductions have failed to meaningfully decrease borrowing costs. Despite the equivalent of three 25 basis point reductions to the federal funds rate since September, many banks were still tightening lending standards as of the end of the year’s third quarter, according to the Federal Reserve’s Senior Loan Officer Opinion Survey, and the average rate on a 30-year fixed rate mortgage is up approximately 0.5 percentage points over the past two months.
Some portion of the stubbornly high borrowing costs can be attributed to uncertainty regarding the second Trump administration. Expected changes to U.S. trade policy, including the prospect of significantly higher tariffs, would likely be inflationary, and investors appear to suspect that long-term rates will be higher as a result.
Of course, there is significant uncertainty. Despite the expressed intent to implement higher tariffs—the proposal being 60% import taxes on all Chinese goods and 10% across the board import taxes on all other countries—there is reason to suspect this policy won’t be enacted as stated. Some think the threat of tariffs is being used to enhance the U.S. position in trade negotiations, and even if the tariffs are enacted, there will be significant workarounds and exceptions.
