Soft landing at risk with high long-term interest rates

📍 The Federal Reserve may be jeopardizing the economy’s hoped-for soft landing by tolerating a rise in long-term interest rates to levels not seen since 2007. The jump raises the risk of a financial meltdown similar to the regional bank failure in March. In the long run, it risks undermining the economy by significantly rising borrowing costs for households and businesses.

📍 The rise in so-called real rates, which exclude the impact of inflation, may have a particularly strong impact. Yields on 10-year inflation-linked Treasuries have risen to levels not seen in the last two decades in recent weeks. The risk is that the rise in long-term rates does more damage than the Fed anticipates.

📍 The rate increase comes at a time when the economy is already experiencing a number of headwinds, ranging from the resumption of student loan payments to an autoworker strike. Market players have identified a number of triggers for the rise in yields, which have now calmed significantly. Among these are investor concerns about rising US budget deficits and dwindling demand for Treasury securities.

📍 Powell has further complicated the situation with the so-called real neutral rate of interest, which is the equilibrium rate that neither stimulates nor retards economic growth. Powell told reporters on September 20 that given the economy’s resiliency in the face of the Fed’s aggressive credit tightening policy, the neutral rate may have risen, at least temporarily.

Source: Bloomberg