Debate Rages on Wall Street: Are Interest Rate Hikes Fueling US Economic Growth?

Debate Rages on Wall Street: Are Interest Rate Hikes Fueling US Economic Growth? 

As the US economy continues to perform strongly month after month, creating hundreds of thousands of new jobs and surprising experts who had predicted a looming downturn, some on Wall Street are beginning to consider a fringe economic theory.

They're questioning whether the series of interest rate hikes over the past two years might actually be fueling economic growth. Instead of the economy thriving despite higher rates, they suggest it might be thriving because of them.

This idea is so unconventional that it's almost heretical in mainstream academic and financial circles, reminiscent of the unorthodox viewpoints expressed by figures like Turkey's President Recep Tayyip Erdogan or the most ardent supporters of Modern Monetary Theory.

However, these new proponents, along with a few who admit to being intrigued by the concept, argue that the economic data is increasingly difficult to ignore. According to some key indicators — such as GDP, unemployment rates, and corporate profits — the current expansion is as robust, if not stronger, than when the Federal Reserve initially began raising rates.

Their argument is that the increase in benchmark rates, from 0% to over 5%, is providing Americans with a significant income boost from their bond investments and savings accounts for the first time in twenty years. This influx of cash, they contend, is leading individuals and companies to spend more, thereby driving up demand and stimulating growth.

In a typical cycle of rate hikes, the additional spending from this group isn't usually enough to offset the decrease in demand from those who stop borrowing money, resulting in a classic downturn induced by the Federal Reserve (along with a corresponding drop in inflation). However, contrary to expectations, some believe that this time the situation is different and might even be slightly stimulative.

One of the primary reasons cited for this difference is the impact of the increasing US budget deficits. With the government's debt doubling over the past decade to $35 trillion, the higher interest rates translate into a significant flow of money into the pockets of bond investors each month.

While this notion that rising rates might stimulate rather than restrict the economy was previously advocated by economists like Warren Mosler, known for his support of Modern Monetary Theory, it was often dismissed as eccentric. Now, seeing some in the mainstream come around to this idea offers a sense of vindication for Mosler.

Even those who were initially skeptical, like Kevin Muir, a former derivatives trader, admit that the evidence seems to support this unconventional theory. Similarly, David Einhorn, a prominent value investor, was persuaded of this idea when observing the slow pace of economic expansion despite near-zero interest rates after the global financial crisis.

However, it's important to note that the vast majority of economists and investors still adhere to the conventional belief that higher rates impede economic growth. They point to rising delinquencies on credit cards and auto loans, as well as a slowdown in job growth, as evidence.

Nevertheless, there is acknowledgment that the impact of higher rates might be less damaging than in the past, partly due to factors such as many Americans locking in low mortgage rates for 30 years during the pandemic.

While there are skeptics and supporters of this new theory, like bond fund manager Bill Eigen, who has adjusted his portfolio to align with its broad principles, the debate continues. Eigen observes increased spending among retirees, highlighting them as among the significant beneficiaries of higher rates.