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I Don't Buy Those Rosy Views of Fed Rate Policy

I still see more monetary lag smacking the economy, and we better brace for commercial real estate and debt woes.
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The International Monetary Fund cheered this week that the U.S. economy has already seen most the expected impact of the Fed's rate hikes, while Europe isn't too far behind.

"We have to recognize that there has been a lot of resilience in the economy, despite the rate hikes that we have seen," said Gita Gopinath, the IMF's Deputy Managing Director, during a CNBC-moderated panel at the World Economic Forum yesterday, as reported by the news outlet. Gopinath said this country's so far seen about "75%" of the monetary lag already reflected in the markets and economy.

The IMF, however, sounds to me a little too cheery to me; I believe monetary lag will continue to be a major headwind to the market and the economy in the months ahead.

I have been preaching about the commercial real estate debt cliff for many months now. Some $540 billion of commercial real estate debt needs to be refinanced -- and at much higher rates in 2024. A good portion of this is on properties in the retail, office, and hotel space, where values have fallen significantly. Delinquency rates in each of these categories have risen to north of 5% and will continue to move higher. This will impact the regional banking system where 30% of this debt is held as well as credit availability to small businesses.

Then we have the impact of higher interest rates on the consumer. Even with the average 30-Year mortgage rate tumbling after briefly hitting 8%, average rates are still more than double their lows in 2021. This has led to lower housing activity as affordability remains near historical lows. Wages will need to go substantially higher, or housing prices move significantly lower to restore equilibrium to the market.

In addition, the average interest rates on credit card balances have moved up more than 5% since the Fed started its monetary tightening program in March of 2022 and hover near historical highs. This is problematic, given revolving balances have shot higher over the past year and now stand at a historical high of around $1.1 trillion. Not to mention balances on buy now, pay later loans surged during this holiday season. Not surprisingly, credit card delinquency rates have started to move over their pre-pandemic levels and will likely continue to deteriorate. Current auto default rates haven't been this high since the early '90s.

Then we have the 800 pound gorilla, something Doug Kass called a long-term "existential threat" in his pessimistic view on the markets on the Daily Diaryyesterday. That is the ballooning federal debt. The administration ran an approximately $2 trillion deficit in FY2023 despite 2.5% GDP growth. In the first quarter of the government's fiscal year 2024, the deficit was $510 billion. At the current yield on the 10-Year Treasury, interest on the national debt would nearly $1.4 trillion annually. Obviously, this is non sustainable and at some point, one has to think the Treasury market will have a significant "hiccup."

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Ironically, this huge amount of deficit spending has papered over a lot of weakness in the economy due to higher rates. How long that lasts is certainly debatable. Government jobs have become a much larger part of overall job growth in recent months, which has compensated for weaker private sector growth. Many sectors of the economy are already in contraction. This includes manufacturing which saw a horrendous negative reading of 43.7 reading in yesterday's Empire State Manufacturing Survey.

Given these factors, I would take the IMF's take on how well the economy has weathered the monetary lag from higher interest rates with a huge grain of salt.

At the time of publication, Jensen had no position in any security mentioned.