Lag Effect of Monetary Policy Showing Signs of Impact

Monetary policy typically filters into the economy with long and variable lags. Therefore, we have likely not felt the full effects of the most aggressive tightening cycle since the 1970s. However, recent economic data suggests consumers and businesses are starting to feel the negative effects of the Fed’s aggressive tightening cycle. Consumers have maintained spending by using credit cards. Banks have kept lending standards tight, and the labor market is showing signs of softening. In this weekly, we explain how the Fed’s monetary policy is catching up to certain areas of the economy.

Labor market cracks emerge: The labor market is typically a lagging indicator as businesses wait until the economy has turned before letting go of employees. While there are currently more job postings than there are Americans unemployed, we are starting to see signs of softening in the labor market. The pace of job gains is slowing, and the unemployment rate is at the highest level since January 2022. In addition, manufacturing employment is contracting, hours worked are declining and temporary workers are falling. These are indications that the labor market will soften further.
Credit card rates high: Americans have increasingly turned to credit cards to fuel their spending but with credit card rates near a record high this is problematic for the economy. According to the most recent New York Fed Survey, Americans owe $1.08 trillion on credit cards and delinquency rates have increased across all income levels. The average credit card balance is ~$6,000, the highest in 10 years, and at current APR rates, it would take borrowers an estimated 17 years to pay off the current balance (if only minimum payments were made).1
Bank lending conditions tight: According to the most recent Fed Senior Loan Officer Survey, fewer banks tightened lending conditions in October compared to the July report. However, 62.7% of banks reported keeping lending conditions unchanged (after tightening sharply in 1H23) while demand across many loan types slowed due to the Fed’s higher rates filtering into loan terms. In addition, the banks surveyed reported a “less favorable economic outlook,” “a deterioration of credit quality of loans,” and “concerns about funding costs.”
Housing at a standstill: The Fed’s tightening cycle has resulted in a deterioration in the housing market. The 30YR mortgage rate reached the highest level since 2000 which has limited Americans’ willingness to move because they don’t want to sacrifice their locked in low rate from previous years. As a result, inventories are tight, prices are high and homeowner affordability is at a record low.

The Bottom Line

The Fed’s aggressive tightening cycle is starting to be felt across the economy. Housing was the first shoe to drop when rates surged and now we are seeing consumer confidence deteriorate as well as delinquencies and bankruptcies rise at the consumer and business level. In a speech last week, Federal Reserve Chairman, Jerome Powell, left the door open for additional rate hikes to get inflation to their target rate. Even if they do not raise rates again, they have reiterated time and time again that rate cuts are not on the horizon and we need to adjust for a higher for longer interest rate regime. This will likely put additional pressure on consumers and businesses.