Before the Federal Reserve's interest rate meeting this month, several "suggestive" articles published by Nick Timiraos, a journalist known as the "New Federal Reserve News Agency", quickly shifted the market sentiment towards a 50 basis point rate cut. The Federal Reserve did not disappoint in the end - the initial rate cut opened this round of easing cycle with a big step forward.

From a certain perspective, Timiraos' articles seem to attract more market attention than the remarks of Wall Street banks and some Fed officials. And in the early morning Beijing time on Friday, this figure who can stir up the storm in the US interest rate market, again published a latest column titled 'Rate cuts cannot guarantee a soft landing'. And the latest signal it sends out seems to have been 'revealed'...

Timiraos wrote that whether the Fed rate cut helps achieve an economic soft landing depends partly on the weakness of the US economy. Success also depends on the downward cost of borrowing, whether it can stimulate new investments and spending to offset the impact of economic slowing.

He believes that achieving a soft landing that reduces inflation to the Fed's target without severely worsening the labor market remains quite challenging, as it ultimately requires new loans to recover growth. Over the past year, bank loan growth has almost stagnated, which is not common outside of recession periods.

Even with a slight decrease in interest rates, many businesses and households may still be unwilling to borrow as the rates they currently face are higher than fixed rates locked in several years ago. And if these borrowers or businesses are not willing to take on new loans, the boost to the economy from rate cuts may be minimal...

Timiraos states that the key issue lies in the difference between debt marginal cost (currently decreasing) and average debt rate (possibly still rising), especially for borrowers who locked in low rates before the Fed started raising rates. With the Fed quickly raising rates after keeping borrowing costs historically low for over a decade, the average debt rates in many industries are still lower than the marginal cost of new credit, even as the Fed is currently cutting rates.

Timiraos cites BCA Research's Chief Global Strategist Peter Berezin's view that the soothing effect of the Fed rate cut on the economy is not significant, as even if the Fed begins to cut rates, the average rates faced by households and businesses will still rise.

The demand is not recovering so quickly under the rate cut.

Timiraos used the housing market as an example to explain this.

He pointed out that the sluggish housing demand in the past year actually illustrates how borrowers are doing everything possible to avoid accepting higher interest rates-- in this case, by not moving (not buying a new house) anymore.

Data from the House of America company shows that in the mortgage market, last week the interest rates on 30-year fixed-rate loans fell below 6.1%, the lowest level in two years, significantly lower than the 7.2% in May. However, according to the Intercontinental Exchange's loan data, the average unpaid mortgage interest rate in July was 3.9%-- as many Americans hold long-term fixed-rate mortgages, this rate has hardly changed in the past two years.

Furthermore, so far, the decline in interest rates has not had much of a promoting effect on housing affordability, which remains at historically low levels. Jody Kahn, Senior Vice President of Research and Consulting at John Burns Real Estate Consulting, said, 'Loose policies have not created a clear surge in demand. A recent survey of 50 residential builders showed a slight increase in web traffic, but overall, opinions vary on whether the increase in web traffic is due to the drop in mortgage rates.'

Currently, most Federal Reserve officials expect that, in addition to the 50 basis points rate cut last week, the Fed will cut rates by another 50 basis points by the end of the year, bringing the federal fund rate target range back to between 4.25% and 4.5% by the end of the year.

However, for debts maturing next year, even if the Fed cuts rates by 100 basis points within the year, corporate borrowers who originally had lower fixed-rate loans may face a significant increase in borrowing costs.

The underestimated impact of lagging transmission effects.

Timiraos pointed out that it is certain that investors are currently more optimistic because the Federal Reserve still has a lot of room to cut interest rates. Lower rates will boost market sentiment, including their expectation that if the weakness becomes apparent, the Federal Reserve will act more quickly to ease the situation. In addition, some smaller companies with higher risks and floating-rate debt and bank loans will also immediately benefit from the breathing space brought by the Fed rate cuts. Fed rate cuts may also weaken the US dollar, allowing emerging market economies to relax rates without worrying about their currency weakening.

However, Timiraos also mentioned that the current loose cycle may face challenges similar to the recent rate hike cycle by the Fed - that the transmission mechanism to the economy may not be smooth. Two years ago, when the Fed raised rates by 75 basis points in large increments, analysts were amazed at how the economy unexpectedly withstood higher monetary costs.

In fact, many families and businesses have been able to maintain resilience because in 2020 and 2021, when interest rates fell to extremely low levels, they locked in low borrowing costs for fixed terms.

Former Kansas City Fed President George stated, "The tightening cycle encounters the fact that we have just provided many companies and households with cash buffers, meaning they no longer need to borrow, which indeed hinders the transmission of (tightening) policy. Whether the same will happen during the downward process of interest rates is still unknown."

Jon Faust, who served as a senior advisor to Powell from 2018 to early this year, stated that central bank governors must acknowledge that their understanding of how monetary policy transmits to the broader economy is very limited. "We already know the direction well enough, so when you haven't applied enough force, you should apply more force. The specific details of 'when' and 'how much' the rate cuts will be depend on the economy and largely on things we can't control."

Some business owners are currently cautious about last week's rate cut. Elias Sabo, CEO of Compass Diversified, said that even with a full percentage point cut, it would not have much effect because we are still at a relatively low level of interest rates. Sabo pointed out that the company has seen a continuous weakening of consumer demand over the past year, with a significant decline between the first and second quarters, followed by a less noticeable softness in the third quarter.

Tedd Friedman, a commercial real estate lawyer in Cincinnati, said few industries can illustrate this dynamic better than real estate. Many owners with much lower debt are currently waiting until the last minute to refinance, hoping for a larger rate cut by the Federal Reserve at that time. Friedman pointed out that the balance sheets of many regional banks are very saturated with many challenging assets, making lenders cautious about refinancing borrowers who are not yet customers.

He predicts that unless there is a significant rate cut in the next year, loan default rates will steadily rise, as owners will not be able to extend maturing loans without injecting more assets. He stated that the performance of these assets currently looks fairly good, but there will be trouble when they need to be extended.

Editor/rice