Back to normal. On July 27, the Federal Reserve increased its key rates by 0.75%. The US central bank proceeded there, for the fourth time in a year, to a sharp increase in its rates. It must be said that these were almost nil during the pandemic, an atypical and temporary situation.
Key rates should thus reach 3.8% next year. Why tighten monetary policy now? Because of inflation at its highest for 40 years, caused in particular by the shortage of components and by the war in Ukraine which is driving up energy prices.
Little explanation. Key rates refer to the price at which commercial banks borrow their cash from the “Fed” (Federal Reserve, the name of the US central bank). By increasing the cost of money, the institution causes a decrease in the money supply, which slows down the rise in prices.
Indeed, the banks pass on the increase to their customers. Real estate rates have already started to rise across the Atlantic. Consumer credit for individuals and business loans are becoming more expensive, and therefore less frequent. As a result, the demand for goods and services decreases, as does money creation, which normally results in lower prices.
Some observers compare the current position of the Fed to the offensive policy of Paul Volcker in the 1980s. The President of the Fed at the time had raised key rates to reach 20%! His successor today, Jérôme Powell, will not go that far. It has to deal with inflation, the causes of which are difficult to control. The prices of energy and raw materials are decided at the world level, and not at the American level.
If the central bank takes the risk of slowing down growth, which will automatically increase unemployment, it is because it has leeway to do so.
But if the central bank takes the risk of slowing growth, which will automatically increase unemployment, it is because it has leeway to do so. Faced with the “Great Resignation” of part of its assets, the American economy is exhausting its labor resources.
In July, it created 528,000 jobs, returning to its pre-pandemic level. The unemployment rate is 3.5%, the lowest level for 70 years. The central bank can therefore afford to conduct a restrictive policy that risks increasing unemployment. “ We need five years of unemployment above 5 % to contain inflation »even declared the economist Larry Summers, former Secretary of the United States Treasury.
Another favorable factor is that commercial banks are doing well. In June, the stress tests for the year 2022 concluded that the level of capital of American banks was generally satisfactory. This means that the 34 establishments concerned by these tests are not too indebted and can absorb a recession. “It is positive for the financing of American companies, which rests at 36 % on bank loan »notes Pascal Quiry, professor of finance at HEC and co-author of the book Vernimmen.
In these favorable conditions, the Fed has begun to reduce the size of its balance sheet, which is close to 9,000 billion dollars following the massive purchases of financial securities during the Covid-19 pandemic. From September, the Fed will resell up to 95 billion dollars of assets per month in order to find a balance sheet of more reasonable size.
The renewed central bank discipline has investors fearing a slowdown in economic growth. The tech-heavy Nasdaq US stock index fell 22% in the second quarter, its worst drop since the 2008 financial crisis.
According to the weekly The Economist56% of Americans believe they are in a recession, although there are debates among experts on the subject. “Credit card loans and mortgage loans are contracted at variable rates in the United States, these loans become more expensive for individuals »explains Pascal Quiry. “Real estate loans are trading above 6 %. Housing construction will slow and house prices will fall”adds Patrick Artus, director of research at Natixis.
Good news, however: individuals have been able to draw on relatively abundant savings following Covid-19. “Household liquid financial wealth has increased sharply following checks from the Trump and Biden administrations”, underlines Christophe Blot, Deputy Director of the Analysis and Forecasting Department at the French Observatory of Economic Conditions (OFCE) and Associate Professor at the University of Paris Nanterre. Their liquidity cushion allows American households to absorb the economic downturn more easily.
And on the corporate front? The rise in interest rates will force them to be more selective in their investments. “The large groups have cash and will just have to postpone some investments. On the other hand, SMEs are directly exposed to the increase in the cost of credit, because they have less liquidity.believes Christophe Blot.
The more restrictive monetary policy also led to a rise in the value of the dollar, which even reached parity with the euro for the first time in twenty years. The explanation is simple: since rates are higher across the Channel, investors prefer to buy American securities, which increases demand for dollars and therefore drives up the value of the greenback, penalizing exports.
The appreciation of the dollar favors American households but handicaps American companies, whose price competitiveness is declining in relation to imports
Economic adviser to US President Joe Biden, Cecilia Rouse, attributed the contraction in GDP in the first quarter to weak exports. On the other side, foreign competitors are becoming more competitive in the US market.
“The United States is in a chronic trade deficit, which means that it is a net importer. However, imports from Europe or Asia become less expensive with the increase in the greenback”, deciphers Pascal Quiry. Ultimately, the appreciation of the dollar favors American households but handicaps American companies, whose price competitiveness is declining in relation to imports.
The picture is less bleak than it appears when we look at real interest rates, that is to say, adjusted for inflation. The latter is indeed at a very high level, around 8.5%. Real interest rates are therefore negative. “If inflation stays at this level, it’s time to borrow! » slips Christophe Blot. The specialist points to another rather reassuring indicator: the gap between the rate of US sovereign debt and that of corporate debt.
“Companies listed on the stock exchange and rated Baa (intermediate-grade credits, editor’s note) by rating agencies borrow at an average rate of 2 % higher than the Fed, i.e. 5 %-5.5 %. This difference of 2 % is less than 3 % observed during Covid-19 »continues Christophe Blot.
In other words, investors are still inclined to take risks in order to lend money to companies. A good sign for the economy.
The level of corporate debt is not alarming either. “The debt to gross operating surplus ratio is in line with the historical average. U.S. corporations posted strong profits in 2021, though they are likely to decline this year”notes Pascal Quiry.
In fact, not all parts of the American economy are in the same boat. Tech is particularly exposed to the downturn, after years of exaggerated euphoria.
“The tech bubble is bursting and that’s a good thing. Same story for other particularly risky asset classes: debt under LBO, SPACs (Special Purpose Acquisition Company, companies intended to raise capital on the stock market to acquire a company, Ed) and cryptocurrencies are down sharply as excess liquidity is removed. Monetary policy is removing all the stupid component of finance”analyzes Patrick Artus.
The LBO (leveraged buy-out) or takeover with leverage is a financial package that consists of acquiring a company by making it indebted; the profits then generated by the acquired company are used to repay its debt. LBO credits total 3,000 billion dollars in the United States, a historic record. They have more than doubled since the financial crisis, driven by very low interest rates. With the rise in credit prices and the prospect of an economic slowdown, these riskier than average credits are neglected by investors who prefer to buy bonds from well-rated companies.
However, US economic growth could be endangered more by the Biden administration’s budgetary decisions than by the Fed’s monetary policy.
“The public deficit should reach around 4 % this year compared to 9 % last year. Congress is blocking the majority of measures proposed by Joe Biden. This differential of 5 % year-on-year is a monstrous shock to households”observes Patrick Artus.
Congress certainly voted on August 8 for a $430 billion plan for the climate and the health of Americans, but the amount had been considerably reduced.
The researcher estimates that across the Atlantic, the disposable income of individuals should fall by 5% this year, inflation increasing faster than the sum of wages and public aid to households.
Congress certainly voted on August 8 a 430 billion dollar plan for the climate and the health of Americans, but the amount had been considerably reduced. The initial program, Build Back Better, presented to Congress last year, provided for $3.5 trillion in spending. It was rejected following the opposition of two Democratic senators. The latest version is therefore practically ten times less ambitious in its envelope.
Let us add that the US economy suffers from another more structural evil: the lack of competition. Margin rates are increasing, which means that prices are growing faster than costs. Frenchman Thomas Philippon, professor of finance at the Stern School of Business in New York, discusses this seemingly surprising phenomenon in his book Competition winners. When France does better than the United States (Threshold, 2022).
Since the beginning of the XXe century, Uncle Sam allowed many sectors of its economy to concentrate under the pressure of industrial lobbies. This is why American households pay more for their plane tickets, their telephone packages or their banking services than their European counterparts. For once, the latter can thank the work of the Commission in terms of the fight against oligopolies. Despite the Eurosceptics, the anti-competitive authorities have been firmer on this side of the Atlantic. For the benefit of consumers.