Financial markets and economies often present an inscrutable visage. As investors, we must endure this opacity. Yet, dissatisfaction with this reality spawns a myriad of “curious” (I exercise restraint here) arguments. One such perplexing assertion is that higher interest rates are beneficial and account for the undiminished economic growth—a notion that leaves one shaking one’s head in disbelief.
A prevalent argument deployed to elucidate the resilience of the US economy posits that high interest rates generate substantial income streams on the asset side of the balance sheet. This claim should immediately invite scrutiny, given the wealth of data and statistics demonstrating that our economic growth model is predominantly debt-based. Hence, higher interest rates principally burden the liabilities side of the balance sheet. One might wonder if these so-called experts have considered this aspect at all.
Bonds don’t make you rich
Moreover, the asset side of the balance sheet is typically dominated by other forms of assets. This should be evident when considering any measure of relative volatility. To support this assertion, let us examine the contributions to changes in the wealth of US households, segmented by stocks, real estate, bonds, and other assets.
As the Federal Reserve graph plainly illustrates, changes in household wealth are overwhelmingly driven by equities and, to a lesser extent, real estate. Thus, while the interest rate component might ostensibly increase income on paper, bonds rarely, if ever, significantly enhance the perceived wealth of US households.
Equities drive changes in US household wealth
When the values of stocks and real estate appreciate, they do so by magnitudes greater than bonds, and when these two asset categories depreciate, overall wealth typically declines. This is hardly a scenario that prompts increased consumer spending.
Nonsense
To provide further clarity on the “minor impact” of bonds on household balance sheets, I calculated the cumulative change in four asset categories from the quarter following the initial COVID-19 outbreak. Equities and real estate account for over 80% of the total increase in US household assets.
Even disregarding the liabilities side of the balance sheet—consider household mortgages, alongside car loans, credit card debt, and student loans—the notion that higher interest income fosters euphoric consumers poised to spend indefinitely is patently absurd.
Continue shopping
Nevertheless, the aforementioned charts offer valuable insights. The total wealth of US households has surged dramatically since Covid-19. Stock prices have soared, house prices have rebounded to record levels after a brief decline despite sharp interest rate increases, and savings accounts now yield respectable returns.
Admittedly, it is unfortunate that this wealth is not more equitably distributed, but on average, Americans have become significantly wealthier in recent years. This newfound affluence must be a delightful sensation as they return to high street shopping.
Jeroen Blokland dissects eye-catching, up-to-date charts on financial markets and macroeconomics in his newsletter, The Market Routine. He also manages his own multi-asset fund and formerly served as head of multi-asset at Robeco.