HSBC strategists are wondering why everyone is obsessed with the Federal Reserve’s next move.
In a note to clients on Monday, HSBC’s head of European credit strategy Jamie Stuttard and team compare the rates climate in the Euro area and in the US, and find that the obsession is a bit misplaced:
“The financial market fixation with when the Fed will hike rates by 0.25% is a curious psychological phenomenon of our times,” Stuttard writes. “Quite apart from the fact that it ignores USD4trillion of Fed balance sheet, the duration of said balance sheet and broader US monetary conditions, the US is in any case not a short-rate based economy.”
And so basically the obsession over what the Fed does next with short-term interest rates makes no sense since this lending rate is simply not what matters to most of the economy.
In its analysis, HSBC highlights two data points which show that long rates are more important where the US economy is concerned.
First, consumer spending, which makes up about two-thirds of gross domestic product, is fueled by long-dated credit, where mortgage debt makes up 66% – or $9.4 trillion – of the $14 trillion in household borrowing.
“The current rate is 3.89%, based on contract interest rates on commitments for 30-year fixed rate first mortgages, which is tied to the [30-year] Long Bond, not to the Fed Funds Target Rate,” Stuttard wrote.
And on the corporate side, about 68% of borrowing is from the bond market, not the bank loan market, and so more impacted by longer-term rather than overnight lending rates. The reverse obtains in Europe, where 88% of funds are from bank loans, while 12% of funding is from the bond market.
Last week, HSBC’s head of fixed-income research Steven Major cut his near-term forecasts for the 10-year treasury yield, writing that the Fed and the European Central Bank tighten monetary policy less aggressively than expected.
But of course, the Fed’s decisions are as much about the immediate signals they send about the US economy as they are about the effect on spending.