What if the Fed were doing exactly the wrong thing? What if, by raising short-term interest rates, it was actually adding to inflation instead of cutting it?
That’s the argument being made by chief investment officer Travis Cocke and his team at Voss Capital, a Houston, Texas-based fund company that has been beating the market for years.
And if they are right, or even just partly right, it would help explain why inflation has remained so strong, despite the Fed’s repeated interest rate hikes.
(There again, the federal government’s persistence in running massive budget deficits may also explain why the economy is running so hot.)
The Voss Capital argument is counterintuitive but not crazy. In a nutshell: Higher interest rates aren’t hurting consumers and companies as much as the Fed thinks, because so many locked in low long-term interest rates during the golden days of the zero interest rate policy. Consumers refinanced their mortgages for 30 years at 3% or less. Companies issued long-term bonds on similar terms.
So raising short-term rates doesn’t raise the cost of these debts, because the money has already been borrowed and the rates fixed.
Meanwhile, many consumers and companies have lots of cash in the bank or in money market funds. Raising interest rates means, suddenly, this money is generating way more interest income than it was before.
The Fed has raised short-term rates 11 times since early 2022, from effectively 0% to around 5.25%.
In this situation, higher rates put more money in their pockets, not less.
Meanwhile, skyrocketing mortgage rates have strangled housing supply. Nobody with a 30 year, 3% fixed mortgage wants to sell their home and lose that cheap debt unless they have to. Result? Inventory on the housing market has vanished. There are very few homes for sale. It’s a seller’s market, and therefore prices have stayed high.
And as housing costs are by far the biggest component of the inflation calculations, that, too, is inflationary.
“The state of consumer balance sheets, and thus the resiliency of the economy, continues to be grossly underestimated as interest rate sensitivity has been overestimated in the aggregate,” the Voss Capital team write in their latest letter to investors. “Consumer’s total interest income is almost 4x larger than consumer interest expense (thanks to ~72% of consumer debt being low fixed rate mortgage debt),” they add.
According to federal government estimates, “the rise in rates has only had -$5B annualized net impact to consumer’s financial picture overall, an amount that is a literal rounding error relative to annual U.S. consumer spending of ~$19 trillion.”
They continue, “Higher rates main impact so far has been to crimp new real estate development at a time when supply/demand are direly out of whack. This may continue to prop up home prices, and recall that the shelter component of CPI comprises the largest weighting at ~40%… The mortgage lock-in effect has kept competing inventory from available existing homes for sale pinned near an all-time low,”
As a result, “we could argue that higher rates are likely more inflationary in the medium term” than counter-inflationary.
Meanwhile, there is a cruel paradox in this argument. While higher interest rates aren’t hurting consumers overall anywhere near as much as the Fed thinks, there is one group who really is getting pummeled: Poorer consumers, which includes not merely the very poor but also many blue collar workers and younger professionals.
After all, they are much less likely to have mortgages, fixed for 30 years at ridiculously low interest rates. They are much more likely to be looking for a place to live, either to buy or to rent, which means restricted housing supply is hurting them badly. And they are also much more likely to be borrowing at short-term rates on credit card loans, and the like.
“Those being hurt are more likely on the lower rungs of the socioeconomic ladder (or at least, are more dependent on high interest revolving credit),” argues Voss. And, “lower rates would spur a quicker and much needed increase in the supply of real estate, helping to pressure prices and rents.”
Voss has an estimated $725 million in assets under management. Its publicly-reported figures, which are subject to strict regulation, show that the firm’s flagship Voss Value hedge fund has outperformed the S&P 500 by a wide margin over three, five and ten years as well as since its launch in 2011 (But it has lagged over the past 12 months). Over ten years through September 30 it had earned an average return of 15.6% a year, compared to 11.9% for the S&P 500
SPX.
