Here’s why high interest rates haven’t caused a US recession

Washington, DC CNN — As the Federal Reserve starts its March policy-making meeting on Tuesday, interest rates remain at a 23-year high, yet unemployment is low, stocks have reached repeated record highs and there’s no recession in sight.

Economists are baffled.

Whenever the Federal Reserve lifts rates to battle high inflation, the risk of a recession increases, and the US economy has typically fallen into an economic downturn under the weight of rising borrowing costs. But that has yet to happen this time around.

America’s economy remains remarkably solid, despite the high interest rates. Economists say that’s partly due to the ultra-low mortgage rates that homeowners locked in during the pandemic, when the Fed slashed rates almost to zero; along with the generally healthy household finances of many Americans in recent years.

Fed Chair Jerome Powell told CBS News last month that it was “critical” for the central bank to raise rates at the aggressive pace it did, even if it meant that Americans might feel some “pain.”

“I was being honest in saying that we thought there would be pain. And we thought that the pain would likely come, as it has in so many past cycles, in the form of higher unemployment,” Powell said. “That hasn’t happened.”

While it’s a phenomenon that has perplexed many economists, it has, more importantly, spared Americans so far from the unforgiving economic pain of a recession.

The ‘golden handcuffs’ of low mortgage rates

The main tool the Fed uses to manage the economy and implement monetary policy is setting its key interest rate, which influences borrowing costs. Whenever it needs to cool the economy by making borrowing more expensive, the Fed raises rates, which should then bring down inflation.

A mortgage is a hefty, but important type of debt that Americans take on to purchase a home, and it is highly subject to the Fed’s rate decisions. That key channel for transmitting monetary policy through to the broader, real economy hasn’t functioned as well as it has in the past.

“The majority of debt is in mortgages and a lot of the people who got locked in at low rates have been telling the Fed to raise rates all it wants. They’re locked in for the next 20 or 30 years,” Dan North, a senior economist at Allianz Trade, told CNN.

The Fed dramatically cut interest rates in the early days of the Covid-19 pandemic to help shore up an economy dealing with high unemployment, prompting mortgage rates to also drop in tandem. But when the US economy rebounded sharply in 2021, it unlocked a frenzy of homebuying, with mortgage rates still at ultra-low levels.

Those homeowners who locked in an affordable 3% mortgage rate, for instance, aren’t likely to trade it for anything higher. The 30-year fixed-rate mortgage averaged 6.74% in the week ending March 14, according to data from Freddie Mac.

That’s down from a two-decade high of 7.79% in late October, but higher than anything seen from 2008 to 2022.

Those ultra-low rates are the so-called golden handcuffs keeping many homeowners from selling their home, even if they need to or want to.

Fed officials reflected in their latest economic projections from December that they expect to cut interest rates three times this year, which would also lower mortgage rates. They release new projections Wednesday when the Fed announces its latest interest rate decision.

Robust household balance sheets

Consumer finances were in excellent shape when the Fed began to raise rates. Many Americans bulked up their savings accounts in 2020 and 2021 thanks to pandemic-related stimulus payments and not spending on services due to restrictions around that time.

The job market was also running red hot when the economy came roaring back from the pandemic in 2021 as employers competed for workers by jacking up wages and beefing up benefits.

Employers are continuing to hire workers at a solid clip, unemployment remains below 4% and workers are still raking in stronger wage gains than anything seen in pre-pandemic times. Americans’ net worth surged at a historic pace from 2019 to 2022, according to the Fed’s triennial Survey of Consumer Finances.

That all means that Americans have been well equipped to deal with the effects of high interest rates.

“Consumer balance sheets have been healthy with fairly low debt rates,” Karen Manna, client portfolio manager at Federated Hermes, told CNN.

“Their portfolios are now performing very well, their fixed-income investments are also giving them more, so no one is feeling forced into having to turn over their debt and reckon with higher interest rates, so this is a much different circumstance than we’ve seen in history,” she said.

The central bank’s March policy-making meeting runs Tuesday and Wednesday of this week, with a decision announced at 2 pm ET on Wednesday, followed by a press conference led by Chair Powell at 2:30 pm ET. Analysts expect the Fed will hold its benchmark lending rate steady for the fifth-straight meeting.