Squeezing The Consumer From Both Sides

Authored by 720Global's Michael Lebowitz via RealInvestmentAdvice.com,

The Federal Reserve raised the Federal Funds rate on December 13, 2017, marking the fifth increase over the last two years.  Even with interest rates remaining at historically low levels, the Fed’s actions are resulting in greater interest expense for short-term and floating rate borrowers. The effect of this was evident in last week’s Producer Price Inflation (PPI) report from the Bureau of Labor Statistics (BLS). Within the report was the following commentary:

About half of the November rise in the index for final demand services can be traced to prices for loan services (partial), which increased 3.1 percent.”

While there are many ways in which higher interest rates affect economic activity, the focus of this article is the effect on the consumer.  With personal consumption representing about 70% of economic activity, higher interest rates can be a cost or a benefit depending on whether you are a borrower or a saver. For borrowers, as the interest expense of new and existing loans rises, some consumption is typically sacrificed as a higher percentage of budgets are allocated to meeting interest expense.  On the flip side, for those with savings, higher interest rates generate more wealth and thus provide a marginal boost to consumption as they have more money to spend.

This article focuses on borrowers and savers to show how the current interest rate cycle is squeezing consumers. Said differently, the rising cost of borrowing is dwarfing the benefit of saving.

Borrowers

As mentioned but worth repeating, personal consumption accounts for the bulk of economic activity. To gauge how higher interest rates might affect individuals’ spending, we classify personal debt into the following five categories: mortgages, home equity lines, auto loans, student loans and credit card debt. The following table shows the amount of debt outstanding in each category and estimates the percentage of each loan type that has fixed interest rates and floating interest rates.

Distinguishing between fixed and floating interest rates is important, as borrowers using fixed-rate loans are largely unaffected by higher interest rates. Accordingly, we focus this analysis on floating rate debt as those borrowers and consumers will see immediate increases in their interest expenses every time the Fed raises rates.

Based on the table, approximately $2.8 trillion of consumer loans outstanding are floating rate. We calculate that every 25 basis point (0.25%) interest rate hike by the Fed will increase interest expense higher by $7 billion annually for these consumers.  Since December 2015, when the Fed began to hike interest rates, the Fed Funds rate and other interest rates to which consumer debt is frequently indexed are about 125 basis points higher. Thus on an annual basis, the additional cost of borrowing is approximately $35 billion. Looking forward, if the Fed raises rates three times in 2018 as they currently forecast, the annual interest expense will increase by another $21 billion to bring the total to $56 billion per year.

The graph below charts Fed Funds, 3-month LIBOR, and average credit card rates to show the nearly perfect correlation between Fed actions and short-term borrowing rates. 3-month LIBOR is the index most frequently used to determine floating rate interest rates.

Data Courtesy: St. Louis Federal Reserve (FRED)

Savers

To do a complete analysis of the effect of higher rates on consumption, we must look beyond the increased interest costs, as quantified above, and also consider the benefits of higher interest rates to savers. According to the Fed, personal savings equals $471 billion. The increase in interest rates should reward savers, which will help offset the economic burden related to the increase in interest expense.

Interestingly, what should happen and what has happened are two different stories. The truth of the situation is that individual savers have barely benefited from higher rates as banks and financial intermediaries are not passing on higher rates to savers. The chart below provided by WalletHub and Wolfstreet.com compares the change in the Fed funds rates and credit card interest rates to instruments of savings. Please note the table does not include the most recent increase in rates on December 13, 2017.

To confirm the data in the chart, we searched for other sources of savings rate data. Data from the FDIC reports that bank savings rates, 3-month CD’s, money market accounts and interest checking rates have increased by 0, 3, 1, and 0 basis points respectively since the Fed began raising rates two years ago.

Based on the graph and the data above, it is fair to say that borrowers have benefited by less than ten basis points (0.10%) on average despite 125 basis points (1.25%) of interest rate increases. Based on total savings of $471 billion, we can approximate the benefit to borrowers is a mere $600 million.

Summary

Consumers are being squeezed. Debt linked to short-term interest rates is rising lockstep with the Federal Funds rate while savings rates remain stubbornly low. While the dollar amounts are not massive, the transmission mechanism of the Fed’s rate hikes is acting like a tightening vice that will result in less consumption and slower economic growth.

One of the key takeaways from the Fed’s action during and following the financial crisis of 2008 has been a prolonged and intentional effort aimed at crushing savers. Near zero percent savings rates is part of the Fed’s strategy to incentive savers to move out of the security of cash and invest in riskier assets and/or consume. Even today, despite the rise in interest rates, banks accept the benefits of higher rates imposed on borrowers while refusing to adjust rates for savers. As one of the primary regulators of the financial system, the Fed could encourage a change in that behavior, but to date, no such influence has even been mentioned. Interestingly, the savings rates that banks earn on deposits at the Fed has increased lockstep with Fed Funds.

After nearly a decade of imposing its unique brand of price controls over the cost of money, the Fed admittedly is not willing to do that which is in the best interest of the general public and continues to adhere to policies that favor their primary constituents, the big banks and major corporations.

Comments

Endgame Napoleon ShrimpinAin'tEasy Wed, 12/27/2017 - 15:45 Permalink

No, here is what the crony-parent Swamp leaders would do: give all individual citizens .0000000000000000000000000001 of a Bitcoin, while providing the citizens, legal and illegal immigrants with demonstrable womb productivity the following amounts of Bitcoin:

1 kid produced for the motherland ~ 10 Bitcoins

2 kids produced for the motherland ~ 20 Bitcoins

3 or more kids produced for the motherland ~ 30 Bitcoins

This crypto welfare program would be passed and championed by RepubliCONs, calling it “tax cuts,” but when interviewed by the MSM, Obama would recommend an increase to 40 Bitcoins for citizens and noncitizens who go over the sex-and-reproduction quota of 3 kids.

After this welfare initiative was inked, the Swamp would pass a bill, renaming Bitcoin FamiliesFirstCoin.

In reply to by ShrimpinAin'tEasy

wmbz Wed, 12/27/2017 - 15:25 Permalink

"the Fed admittedly is not willing to do that which is in the best interest of the general public and continues to adhere to policies that favor their primary constituents, the big banks and major corporations". Of course the fed is pissing down on the heads of the general public . They look at the serfs as pissants. Same as it always was.

Bigly Wed, 12/27/2017 - 15:29 Permalink

Who are the 12% who have an adjustable rate mortgage? Unless this is a 2-3month stopover to what you actually want i cannot fathom someone is stupid enough to not see rates are moving UP. This indicates to me there are still way too many in mortgages they simply cannot afford.

AlphaSeraph Bigly Wed, 12/27/2017 - 15:41 Permalink

America has a much larger % of fixed rate mortgages than here in Canada. A much higher percentage of mortgage holders here in Canada are variable. Furthermore, "THE" American Mortgage is a 30 year fixed. In Canada the typical is a 25 year amortization with 5 year mortgages. The vast majority of Canadians are on 5 year terms and must refinance at such intervals. We have way more than 12% of mortgages as variable.A common variable rate in Canada right now is 1.85% to 2.2%. Call it 2%. When/if rates go to JUST 5%, Canadian housing prices (and the big banks, and their savings account depositors) are going to get RUN OVER.In the 2013 Federal Budget, Harper's govt put in bail in laws. When the Canadian housing bubble takes down a bank (or 3), depositors are going to get ass rammed and a huge percentage of the Canadian pop. will be under water debt serfs. Canadian law stipulates that mortgages CANNOT be walked away from (like in the US). The only way to walk away from a mortgage in Canada is to 1) sell the house for more than the mortgage 2) pay it off the old fasioned way.A lot of young Canadians (and retarded "normalcy bias" speculators) are going to have negative net worth for a long, long time.

In reply to by Bigly

Endgame Napoleon Bigly Wed, 12/27/2017 - 15:58 Permalink

The sales tactic plays to the hope-springs-eternal gene in humans. [Everyone] wants to think his or her wages will go up, even in an era of persistent wage stagnation.

Why aren’t they building more affordable houses in safe areas, where many of these young couples who would normally buy homes want to live? Because, that is where they lived before they got the proverbial “real job,” finding out the bitter truth that, other than a few managers, most of those real jobs pay $10 per hour for non college grads (who are often preferred) or $12 per hour for college grads.

Either way, it is not a home-buying wage for a couple—OR even a rent-paying wage for single people who want the dignity of an apartment—unless they have unearned income from a spouse or from the layered welfare offerings, from subsidized rent to free food and child tax credits up to $6,444, which are available to single moms who stay below the earned-income limit for welfare, mostly by working part time for those wages.

In reply to by Bigly

fbazzrea Endgame Napoleon Wed, 12/27/2017 - 16:28 Permalink

Why aren’t they building more affordable houses in safe areas...perfect example in my hometown: two new speculative homes recently built. nice homes but sale prices are $129k and $150k. that's fine. cheap in most places and worth every penny i'm sure. problem is..."The median income for a household in the city was $22,667... The per capita income for the city was $11,258."--Wikipediaseveral small ~ 14'x40' frame homes have been moved in recently. owners creating nice homesteads with obvious pride. most existing homes were built pre-1960 and are generally in need of electrical/plumbing updates. local oilpatch played out long ago. we used to lament missing out on the fracking boom but are now grateful as our water wells remain potable. still... tough economy. no jobs. just mostly poor people, including me, but we've got TWO NEW ~$150k SPEC HOMES AVAILABLE!!  /:

In reply to by Endgame Napoleon

Gap Admirer fbazzrea Wed, 12/27/2017 - 16:46 Permalink

"The median income for a household in the city was $22,667... The per capita income for the city was $11,258."

Is this in Uganda or something? Per capita income of about $5/hour. That was minimum wage in the U.S. in the 1980s, I believe.

Personally, I'm fine with builders building homes that won't sell as long as the government doesn't get involved, sending the building my tax dollars to bail him out. Let the builder and/or bank take the loss and build properties that will sell next time. The free market, if we can ever get close to there, works.

In reply to by fbazzrea

rejected Wed, 12/27/2017 - 15:40 Permalink

I call Bullshit!Haven't seen any increase in interest on my savings PERIOD.And the interest charged on credit cards was from 10 to 30 percent when Feds rates were almost zero. Only ones that made out were the TBTJ banks and other corporations.

fbazzrea Wed, 12/27/2017 - 16:07 Permalink

Interestingly, the savings rates that banks earn on deposits at the Fed has increased lockstep with Fed Funds.that's what the Federal Reserve Fund rate determines... how much banks earn on deposits at the Fed.

pitz Wed, 12/27/2017 - 16:46 Permalink

Of course.  This is why we are entering a "post-consumerism" economy.  There are far more borrowers than there are lenders in the United States.  

BraceforImpact Wed, 12/27/2017 - 16:49 Permalink

I'm no doctorate economist, but a group of them (preferably Austrians, Keyesians are morons) should sit down and actually SORT through this BS and find real answers.  Inflation is closer to 8% per year if not more, I pay around 40% in taxes (if you include everything) and I'm an engineer with student debt under 30.  The best part? I consented to NONE of this. Social Security mathematically WON'T EXIST, they full-on admit this in their own quarterly report. Your 401k? LOL I'll need $1 million PER YEAR just to maintain living in a 700sq ft. basic apartment when I retire, if you use real inflation and assumming it's linear, which it WON'T be because it CAN'T be.  Oh well, no one cares and 1 in 5 can't even read.  BraceForImpact, there's literally no way out of this but total economic collapse, backed by 5000 years of morons making the same mistakes...this is just 1000x bigger lol 

wdg BraceforImpact Wed, 12/27/2017 - 17:45 Permalink

What confounds me is why are you and the vast majority of Americans who are being plundered by these gangsters not marching by the millions to Washington and New York with pitchforks and other suitable weapons in hand to clean out the den of vipers? Where are the young leaders? This is much worse than before the American Revolution. 

In reply to by BraceforImpact