Despite some recent twists and turns, as the economy booms and the stock market stabilizes, it is difficult to promote the claim that high interest rates have a significant negative impact on the economy.

So what if policymakers just decide to keep interest rates unchanged for a longer period of time and not cut interest rates throughout 2024? Despite the current situation, this issue still shudders Wall Street and makes ordinary people uneasy.

Quincy Krosby, chief global strategist at LPL Financial, said: “When interest rates start to rise, adjustments must be made.” “The math has changed, so the question is, if interest rates stay high for longer, will we run into problems?”

At the beginning of 2024, investors did not expect a longer and higher position, but this is something they must deal with now, because it turns out that inflation is more sticky than expected, hovering around 3%, while the Federal Reserve's target is 2%.

Recent statements by Federal Reserve Chairman Powell and other policy makers have strengthened the view that interest rates will not be cut in the next few months. In fact, some people are even talking about the possibility of raising interest rates one or two more times in the future if inflation does not ease further.

This leaves people with many questions: when exactly will monetary policy be relaxed, and what impact the central bank's remaining position will have on financial markets and the economy as a whole.

Krosby said that as the current earnings season heats up, some answers will soon be revealed. Company executives will provide key details beyond sales and profits, including the impact of interest rates on profit margins and consumer behavior. “If there are any signs that businesses must start cutting costs, leading to problems in the job market, then this is a potentially problematic path with interest rates so high,” he said.

Despite the recent 5.5% drop in the S&P 500, financial markets have remained generally stable against the backdrop of rising interest rates. With the Federal Reserve standing still, the general market index has risen 6.3% so far this year, 23% higher than the low at the end of October 2023.

Higher interest rates may not be a bad thing

History tells us that hawkish Feds have varied effects on markets and the economy.

Generally speaking, higher interest rates are a good thing, as long as it relates to economic growth. The last time this happened was when then-Federal Reserve Chairman Paul Volcker (Paul Volcker) curbed inflation by raising interest rates sharply and ultimately deliberately dragged the economy into recession.

There are few precedents for the Federal Reserve to cut interest rates during this period of strong growthThe annualized growth rate of US GDP is expected to reach 2.4% in the first quarter of 2024, which will be the seventh consecutive quarter with a growth rate of more than 2%. The preliminary GDP value for the first quarter will be announced on Thursday.

Over the past few decades, rising interest rates have not been linked to a recession.

In contrast, the Federal Reserve Chairman is often blamed for keeping interest rates too low for too long, leading to an internet bubble and the collapse of the subprime mortgage market, triggering two of the century's three recessions. In another example, when the COVID-induced recession occurred, the Federal Reserve's benchmark fund interest rate was only 1%.

In fact, some people think that the Federal Reserve and its widespread influence on the $27.4 trillion US economy have been exaggerated.

David Kelly, chief global strategist at J.P. Morgan Asset Management, said, “I think,Active monetary policy doesn't boost the economy as much as the Federal Reserve thinks.”

Kelly pointed out that in the 11 years between the financial crisis and the COVID-19 pandemic, the Federal Reserve tried to use monetary policy to raise inflation to 2%, but most failed. Over the past year, the fall in the inflation rate coincided with tight monetary policy, but Kelly suspected that the Federal Reserve had a lot to do with this.

Other economists have put forward similar views, that is, the main problem affected by monetary policy, demand has remained strong, while supply issues, which are largely unaffected by interest rates, have been the main driving force behind the slowdown in inflation.

Kelly said that where interest rates work is the financial market, which in turn affects the state of the economy.

He said, “Interest rates that are too high or too low can distort financial markets. In the long run, this will ultimately damage the economy's productive capacity and may lead to bubbles that will destabilize the economy.”

He added, “I don't think they set interest rates at a level that is inappropriate for the economy. I do think interest rates are too high for the financial market. They should try to return to normal levels, not low levels, but normal levels, and keep interest rates at normal levels.”

Longer and higher interest rates are a likely path

As a matter of policy, Kelly said,This will translate into three 0.25 percent interest rate cuts this year and next, lowering the federal funds rate to the 3.75%-4% range. This is roughly in line with the 3.9% interest rate expected by members of the Federal Open Market Committee (FOMC) in the bitmap forecast last month at the end of 2025.

Futures market expectations suggest that the federal funds rate will reach 4.32% by December 2025, indicating a higher interest rate trajectory.

Although Kelly advocates “gradual normalization of policies,”He does believe that the economy and the market can withstand long-term higher interest rates.

In fact,He believes that the Federal Reserve's current 2.6% neutral interest rate forecast is unrealisticThis idea is drawing attention on Wall Street. For example,Goldman Sachs recently believed that the neutral interest rate (neither a stimulatory rate nor a restrictive rate) could be as high as 3.5%. Cleveland Federal Reserve Bank Governor Loretta Mester also recently said that long-term neutral interest rates are likely to be higher.

This makes expectations of the Federal Reserve's policy tend to cut interest rates slightly, but they will not return to the near-zero interest rate level that prevailed in the years after the financial crisis.

In fact, in the long run, the federal funds rate dating back to 1954 averaged 4.6%, even considering nearly zero interest rates for nearly seven years after the 2008 crisis to 2015.