Economics
Why the Fed keeping rates higher for longer may not be such a bad thing
US Federal Reserve Board Chairman Jerome Powell arrives to testify at a House Financial Services Committee hearing on the “Federal Reserve’s Semi-Annual Monetary Policy Report,” on Capitol Hill in Washington, DC, March 6, 2024.
Mandel Ngan | Afp | Getty Images
With the economy humming along and the stock market, despite some recent twists and turns, hanging in there pretty well, it’s a tough case to sell that higher interest rates are having a substantially negative impact on the economy.
So what if policymakers just decide to keep rates where they are for even longer, and go through all of 2024 without cutting?
It’s a question that, despite the current conditions, makes Wall Street shudder and Main Street queasy as well.
“When rates start climbing higher, there has to be an adjustment,” said Quincy Krosby, chief global strategist at LPL Financial. “The calculus has changed. So the question is, are we going to have issues if rates remain higher for longer?”
The higher-for-longer stance was not what investors were expecting at the beginning of 2024, but it’s what they have to deal with now as inflation has proven stickier than expected, hovering around 3% compared with the Federal Reserve’s 2% target.
Recent statements by Fed Chair Jerome Powell and other policymakers have cemented the notion that rate cuts aren’t coming in the next several months. In fact, there even has been talk about the potential for an additional hike or two ahead if inflation doesn’t ease further.
That leaves big questions over when exactly monetary policy easing will come, and what the central bank’s position to remain on hold will do to both financial markets and the broader economy.
Krosby said some of those answers will come soon as the current earnings season heats up. Corporate officers will provide key details beyond sales and profits, including the impact that interest rates are having on profit margins and consumer behavior.
“If there’s any sense that companies have to start cutting back costs and that leads to labor market trouble, this is the path of a potential problem with rates this high,” Krosby said.
But financial markets, despite a recent 5.5% sell-off for the S&P 500, have largely held up amid the higher-rate landscape. The broad market, large-cap index is still up 6.3% year to date in the face of a Fed on hold, and 23% above the late October 2023 low.
Higher rates can be a good sign
History tells differing stories about the consequences of a hawkish Fed, both for markets and the economy.
Higher rates are generally a good thing so long as they’re associated with growth. The last period when that wasn’t true was when then-Fed Chair Paul Volcker strangled inflation with aggressive hikes that ultimately and purposely tipped the economy into recession.
There is little precedent for the Fed to cut rates in robust growth periods such as the present, with gross domestic product expected to accelerate at a 2.4% annualized pace in the first quarter of 2024, which would mark the seventh consecutive quarter of growth better than 2%. Preliminary first-quarter GDP numbers are due to be reported Thursday.
In the 20th century, at least, it’s tough to make the argument that high rates led to recessions.
On the contrary, Fed chairs have often been faulted for keeping rates too low for too long, leading to the dot-com bubble and subprime market implosions that triggered two of the three recessions this century. In the other one, the Fed’s benchmark funds rate was at just 1% when the Covid-induced downturn occurred.
In fact, there are arguments that too much is made of Fed policy and its broader impact on the $27.4 trillion U.S. economy.
“I don’t think that active monetary policy really moves the economy nearly as much as the Federal Reserve thinks it does,” said David Kelly, chief global strategist at J.P. Morgan Asset Management.
Kelly points out that the Fed, in the 11-year run between the financial crisis and the Covid pandemic, tried to bring inflation up to 2% using monetary policy and mostly failed. Over the past year, the pullback in the inflation rate has coincided with tighter monetary policy, but Kelly doubts the Fed had much to do with it.
Other economists have made a similar case, namely that the main issue that monetary policy influences — demand — has remained robust, while the supply issue that largely operates outside the reach of interest rates has been the principle driver behind decelerating inflation.
Where rates do matter, Kelly said, is in financial markets, which in turn can affect economic conditions.
“Rates too high or too low distort financial markets. That ultimately undermines the productive capacity of the economy in the long run and can lead to bubbles, which destabilizes the economy,” he said.
“It’s not that I think they’ve set rates at the wrong level for the economy,” he added. “I do think the rates are too high for financial markets, and they ought to try to get back to normal levels — not low levels, normal levels — and keep them there.”
Higher-for-longer the likely path
As a matter of policy, Kelly said that would translate into three quarter-percentage point rate cuts this year and next, taking the fed funds rate down to a range of 3.75%-4%. That’s about in line with the 3.9% rate at the end of 2025 that Federal Open Market Committee members penciled in last month as part of their “dot-plot” projections.
Futures market pricing implies a fed funds rate of 4.32% by December 2025, indicating a higher rate trajectory.
While Kelly is advocating for “a gradual normalization of policy,” he does think the economy and markets can withstand a permanently higher level of rates.
In fact, he expects the Fed’s current projection of a “neutral” rate at 2.6% is unrealistic, an idea that is gaining traction on Wall Street. Goldman Sachs, for instance, recently has opined that the neutral rate — neither stimulative nor restrictive — could be as high as 3.5%. Cleveland Fed President Loretta Mester also recently said it’s possible that the long-run neutral rate is higher.
That leaves expectations for Fed policy tilting toward cutting rates somewhat but not going back to the near-zero rates that prevailed in the years after the financial crisis.
In fact, over the long run, the fed funds rate going back to 1954 has averaged 4.6%, even given the extended seven-year run of near-zero rates after the 2008 crisis until 2015.
Government spending issues
One thing that has changed dramatically, though, over the decades has been the state of public finances.
The $34.6 trillion national debt has exploded since Covid hit in March 2020, rising by nearly 50%. The federal government is on track to run a $2 trillion budget deficit in fiscal 2024, with net interest payments thanks to those higher interest rates on pace to surpass $800 billion.
The deficit as a share of GDP in 2023 was 6.2%; by comparison, the European Union allows its members only 3%.
The fiscal largesse has juiced the economy enough to make the Fed’s higher rates less noticeable, a condition that could change in the days ahead if benchmark rates hold high, said Troy Ludtka, senior U.S. economist at SMBC Nikko Securities America.
“One of the reasons why we haven’t noticed this monetary tightening is simply a reflection of the fact that the U.S. government is running its most irresponsible fiscal policy in a generation,” Ludtka said. “We’re running massive deficits into a full-employment economy, and that’s really keeping things afloat.”
However, the higher rates have begun to take their toll on consumers, even if sales remain solid.
Credit card delinquency rates climbed to 3.1% at the end of 2023, the highest level in 12 years, according to Fed data. Ludtka said the higher rates are likely to result in a “retrenchment” for consumers and ultimately a “cliff effect” where the Fed ultimately will have to concede and lower rates.
“So, I don’t think they should be cutting anytime in the immediate future. But at some point that’s going to have to happen, because these interest rates are simply crushing particularly low-income-earning Americans,” he said. “That is a big portion of the population.”
Economics
U.S. tariff rates under Trump will be higher than the Smoot-Hawley levels from Great Depression era
U.S. President Donald Trump holds a chart next to U.S. Secretary of Commerce Howard Lutnick as Trump delivers remarks on tariffs in the Rose Garden at the White House in Washington, D.C., on April 2, 2025.
Carlos Barria | Reuters
The tariff policy outlined by President Donald Trump on Wednesday appears set to raise the level of U.S. import duties to the highest in more than 100 years.
The U.S. introduced a baseline 10% tariff on imports, but also steep country-by-country rates on some major trading partners, including China. The country-by-country rates appear to be related to the trade deficit the U.S. has with each trading partner.
Sarah Bianchi, Evercore ISI chief strategist of international political affairs and public policy, said in a note to clients late Wednesday that the new policies put the effective tariff rate above the level of around 20% set by 1930’s Smoot-Hawley Tariff Act, which is often cited by economists as a contributing factor to the Great Depression.
“A very tough and more bearish announcement that pushes the overall U.S. weighted average tariff rate to 24%, the highest in over 100 years – and likely headed to as high as 27% once anticipated 232s are complete,” Bianchi wrote. The “232s” is a reference to some sector-specific tariffs that could be added soon.
JPMorgan’s chief U.S. economist Michael Feroli came up with similar results when his team crunched the numbers.
“By our calculations this takes the average effective tariff rate from what had been prior to today’s announcement around 10% to just over 23%. … A White House official mentioned that other section 232 tariffs (e.g. chips, pharma, critical minerals) are still in the works, so the average effective rate could go even higher. Moreover, the executive order states that retaliation by US trading partners could result in even higher US tariffs,” Feroli said in a note to clients.
An estimate from Fitch Ratings was in the same range, with a report saying the tariff rate would hit its highest level since 1909.
Trump referenced the Smoot-Hawley Act in his Rose Garden remarks on Wednesday. The president said the issue was not the tariffs imposed in 1930 but the previous decision to remove the higher tariffs that existed earlier in the 20th century.
“It would have never happened if they had stayed with the tariff policy. It would have been a much different story. They tried to bring back tariffs to save our country, but it was gone. It was gone. It was too late,” Trump said.
The full economic impact of the new tariffs will likely depend on how long they are in place and if other countries retaliate. Trump and Treasury Secretary Scott Bessent have indicated that the country-by-country tariffs could come down if those trade partners change their policies.
JPMorgan global economist Nora Szentivanyi warned that Trump’s tariffs were likely to push the U.S. and global economy into a recession this year if they are sustained.
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