Fiscal Tightening

When the central bank decides to tighten its monetary policy by raising interest rates, it’s essentially hitting the brakes on the economy.

This action makes borrowing more expensive for both consumers and businesses.

While the primary aim is to control inflation, it has the effect of cooling down consumer spending and business investment.

The ripple effects can be significant: a reduction in spending slows down economic growth, contracts the job market, and could eventually lead to a recession if the tightening is too abrupt or goes on for too long.

Financial markets often react negatively to tightening, as higher interest rates can lead to lower asset prices.

Recession signal

Its very important to understand the interest rate LAG on the economy. Things don’t change quickly when interest rates are increased.

Interest rates affect different businesses at different times, depending on when they need to re-finance.

Same with the general population, on things like re-mortgaging out of fixed rate periods. 

People and businesses might have maturity/ re-borrowing terms of 2, 3, 5 10 years.

That debt might not be rolled over for a long time. There will be a huge number of people and businesses who do not have to worry about the downside of high interest rates for potentially quite a long time.

Plus during COVID, the USA printed $9t, which means that the interest rates could take even longer to have an effect, because of all of the residual cash in the system, and in savings.

Nearly always, however, recessions happen after the interest rates have not just stopped rising, but are actually coming down. So for a leading indicator, we look for a stop in tightening first, and then easing.

Track this yourself

You can track the US interest rate easily on TradingView: https://www.tradingview.com/chart/v7ZG3yMA/?symbol=ECONOMICS%3AUSBP