This is a story about how interest rate hikes are supposed to work, and why they might not be working as intended right now—at least according to one of the bond market’s biggest names.
Typically, when inflation becomes an issue in the economy, the Federal Reserve raises interest rates to fight it, effectively increasing borrowing costs for businesses and consumers nationwide. The goal is to stabilize prices by incentivizing more saving and less spending, which slows economic activity.
This orthodox monetary policy usually works quite well. Debatably, we’ve all witnessed its success over the past few years in Federal Reserve Chair Jerome Powell’s battle against inflation.
Between March 2022 and July 2023, Powell raised the Fed funds rate from near-zero to a range between 5.25% and 5.5%. The subsequent rise in borrowing costs across the U.S. helped to stall the once-surging housing market, a key source of inflation; led to an at least mildly deflationary stock market rout in 2022; and put a lid on consumers’ inflation expectations (which can devolve into self-fulfilling prophecies). In turn, year-over-year inflation sank from its four-decade high above 9% in June 2022 to just 3% by July of the following year.
However, since then, despite the consistent economic drag from higher interest rates, inflation has failed to drop to the Fed’s 2% target, sticking in a range between 3% and 3.5%. Some economists argue this stall is the result of Powell’s decision to hold interest rates steady for nearly a year now instead of implementing more rate hikes. But Rick Rieder, chief investment officer of global fixed income and head of the global allocation team at BlackRock, has a different theory that seems to go against economic orthodoxy.
In an interview with Fortune, Rieder argued the Fed’s interest rate hikes are the wrong medicine for the economy’s current disease. “It’s ambiguous to me today, at best, whether a higher [interest] rate helps bring down inflation versus actually contributes to it,” he said.
The 14-year BlackRock veteran, who oversees $2.4 trillion in assets at the world’s largest asset manager and is known as one of the leading voices in the bond market, argued that the Fed may need to change its strategy and opt for rate cuts in order to fight the last remnants of inflation. And it’s all because many low-debt, cash-rich consumers and businesses—particularly baby boomers and Fortune 500 giants—are actually profiting from higher rates.
The government-spending–driven savings boom and asset price appreciation of the COVID era enabled these large businesses and well-off consumers to become net lenders, rather than borrowers, according to Rieder. Now, with higher interest rates offering a hefty reward to anyone with the cash to lend, the private sector’s lender status has created a steady, inflationary income stream in a key part of the economy.
“If you think about what happened in the last couple of years, the public sector made a huge transfer to the private sector. Companies turned out their debt, individuals de-levered, and you have a dynamic where you have huge amounts of savings and money in money-market funds,” he explained. “Now, if you look at service-level inflation, some of it is because you have so much income flowing through the system with these companies and individuals that it actually gets recirculated.”
Not long ago, Rieder’s hypothesis—that higher interest rates may be benefiting a select segment of the population that is then boosting inflation—would have been considered unconventional on Wall Street, to say the least. But now, even Fed officials are beginning to consider “the possibility that high interest rates may be having smaller effects than in the past,” according to the minutes of the May 1 Federal Open Market Committee (FOMC) meeting. Here’s why some of Wall Street’s top minds, and the Fed’s best economists, are shifting their thinking about the impact of higher interest rates on the U.S. economy.
A baby boomer economy
Rieder pointed to older Americans’ striking wealth and desire to spend, which has been bolstered by their new role as lenders in a higher interest rate environment, as one of the reasons the Fed has struggled to control the critical services component of inflation.
Services inflation—particularly core services ex-shelter inflation, which includes prices for things like medical care, entertainment, tuition, and insurance, but not housing or energy—has been one of the Fed’s biggest areas of concern for years. As far back as November 2022, Powell said this metric “may be the most important category for understanding the future evolution” of inflation. There are…
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