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How the U.S. Economy Weathered 5% Interest Rates

How the U.S. Economy Weathered 5% Interest Rates

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Surprising Stability

Nearly a year ago, the Federal Reserve raised its benchmark interest rate to its current level of 5.25% – 5.5%, the highest it’s been in multiple decades. This move was widely anticipated to stifle inflation by slowing the economy. However, the U.S. weathered those rates surprisingly well, and now economists have a pretty good idea why.

Rate Resilience

One reason why the U.S. economy has fared so well is likely that it is less sensitive to interest rates compared to other economies.

Floating-rate and shorter-term debt, including mortgages, is more common overseas, while the U.S. primarily holds long-dated debt at fixed rates. This gives borrowers — like corporations issuing bonds and households purchasing mortgages — a larger cushion of time before they are forced to refinance at higher rates.

Given enough time, the economy will gradually transition to those new rates, but that can take several years. For households who purchased or refinanced a 30-year mortgage in 2021, when rates were at dramatic lows, it could take decades. The same goes for U.S. corporations that issued 10- or 20-year bonds in 2021.

Gradual Grind

The U.S economy may be more rate resilient, but that doesn’t mean the economy is immune to the effects of hikes. Elevated borrowing costs for mortgages, credit cards, and auto loans have weighed heavily on consumers. The rise in rates has also contributed to the ongoing housing freeze by discouraging sellers from jumping back into the market.

Looking at the bigger picture, the long and gradual transition to higher interest rates in the U.S. fuels cautious optimism for the slowly cooling economy. On one hand, the lack of interest rate sensitivity could keep growth elevated and, in turn, inflation sticky. On the other, the slow, steady impact of high rates gives the economy more time to adapt to a changing landscape.

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