Rare trifecta of soaring stocks, cheap loans and low inflation coming to an end

  • By David J. Lynch,
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For most of the past decade, as the U.S. economy marched through the second-longest expansion in its history, Americans enjoyed a rare trifecta: soaring stock values, cheap loans and consumer prices that rarely rose.

That favorable climate benefited everyone from people nearing retirement to those buying their first homes or just filling their gas tanks.

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But suddenly, the good fortune is melting away, imperiling the props that have supported American economic confidence and incomes and intensifying pressure on President Trump to deliver the faster growth and higher wages he has promised.

Consumer prices by a key measure are rising at their fastest point in seven years, with mass consumer companies such as McDonald’s (MCD) and Amazon.com (AMZN) increasing prices on some of their popular offerings. Mortgages and business loans are becoming more expensive. And after peaking in late January, the Dow Jones industrial average (.DJI) is now roughly flat on the year.

The result is that Americans have to spend more money on staples, pay more to borrow money to buy big-ticket items such as cars and homes, and are seeing less growth in their investments. These factors will probably pinch Americans particularly during spring and summer, when home-buying and driving peak.

Overall, the economy is still doing well today, and many economists don’t expect any major disruption this year. But the rise in consumer prices and interest rates — and the stagnating stock market — are seen by many as warning signs that this period of easy growth could be ending.

“You’re moving from being benign to biting. It is a fundamental shift from the world we’ve known,” said economist Diane Swonk of Grant Thornton. “I fear we’re seeding a boom-bust cycle.”

That fear, experts say, explains why the stock market has had such a difficult year.

“The markets always lead the economy,” said David Rosenberg, chief economist and strategist at Gluskin Sheff.

The transition to a less-forgiving era was underscored when the yield on the 10-year Treasury note, a borrowing benchmark, touched 3 percent, a level it hadn’t reached since 2013. Investors say interest rates will probably continue to rise, especially with the Federal Reserve poised to further tighten monetary policy.

From its March 2009 low to its peak in late January, the Dow roughly quadrupled, making millions of Americans wealthier. But now as bonds begin offering investors a better rate of return without the risk of losses that stockholders face, stocks’ performance is down. Higher interest rates will also push up corporate borrowing costs and erode profits, another negative for stocks. Already, investors in four of the past five weeks pulled money from mutual funds investing in domestic stocks and added to their bond funds, according to the Investment Company Institute, an industry group.

The recent combination of falling stock prices and rising bond yields troubled some financial market veterans. “It raises the risk of a deep and disruptive drop by share prices. A good analogy? 1987,” said John Lonski, chief economist for Moody’s Analytics, referring to the stock market crash of 1987. “This is not a favorable portent. It’s an ominous development.”

Borrowing costs for ordinary Americans are on the way up, too.

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To battle the financial crisis in 2008, the Fed pushed short-term interest rates to near zero and left them there for years. Easy money helped consumers and businesses afford new purchases and aided in the healing of the economy.

Rising interest rates will inflate borrowing costs for consumers and companies alike, adding $100 billion to annual debt-servicing costs, Rosenberg said. That is money that consumers otherwise could spend on houses, clothes, and cars or that businesses could devote to new machinery.

But today’s rising borrowing costs will hit an economy loaded with debt, meaning that people and businesses will have to spend even more on interest payments. Corporations outside the finance industry at the end of last year owed creditors more than $49 trillion.

That debt burden has grown since 2004 at a rate four times faster than the economy, according to the Federal Reserve.

Despite progress in paying off mortgage balances since the housing collapse, American households still owe more in debt than they make in disposable income. Credit card delinquency rates have begun inching up.

Interest payments (not including mortgages) now take as big a bite out of the typical American’s income as in mid-2008, when the crisis was gathering force, according to the Federal Reserve.

With interest rates headed higher, some experts worry that consumer borrowing no longer will be able to power the economy.

“You still needed that growth . . . to drive the meager expansion that we’ve seen,” said Daniel Alpert, managing partner of Westwood Capital. “How much on the household side was that debt being increased in order to make ends meet, i.e. sustain existing levels of spending?”

Americans already must pay more for mortgages, though that is not yet influencing home-buying. Average rates on a 30-year fixed rate mortgage hit 4.5 percent this week, up from about 4 percent at the beginning of the year. That change would add about $88 to the monthly cost of a $300,000 mortgage, yet applications for new loans held steady this week, according to the Mortgage Bankers Association.

“As rates rise over the next couple of years, they will weigh on housing demand,” said Alan Levenson, chief economist for T. Rowe Price.

Rising consumer prices have not been a significant problem for years. That may be about to change. On Friday, the Commerce Department reported that prices, excluding food and energy products, rose at a 2.5 percent annual clip in the first three months of 2018.

A milestone for bonds

The yield on the 10-year Treasury note is over 3% for the first time in 4 years.

Oil prices are nearing $70 a barrel, up roughly 50 percent since August, and Trump’s tariffs on steel, aluminum and Chinese goods will raise costs. The boost in spending coming from the big tax cut passed in December could further push up prices.

That, in turn, may lead the Fed to more quickly move rates higher.

“The economy will run hotter than it would have because of the tax cuts and spending increases,” said economist Michael Strain of the American Enterprise Institute. “That will push the Fed to increase interest rates a little faster than they otherwise would have.”

After topping $4 per gallon in 2008, gas prices have remained below $3 for more than three years.

But they have been creeping higher for several months. With the nationwide average now at $2.80, filling up will cost the average household an additional $190 this year, according to the U.S. Energy Information Administration.

While financial conditions are tightening, they remain comparatively easy. The Fed’s benchmark interest rate, currently hovering between 1.5 percent and 1.75 percent — would need to reach 3 percent before it begins slowing the economy, William Dudley, president of the New York Federal Reserve Board, said in a recent speech.

The Fed is expected to increase short-term borrowing rates three more times this year, in quarter-of-a-percentage-point increments. If it does, and continues the trend into next year, rates will reach the 3 percent level by mid-2019, according to Capital Economics.

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