Cash-Rich Consumers Could Mean Higher Interest Rates for Longer

Washington’s response to the pandemic left household and business finances in unusually strong shape, with higher savings buffers and lower interest expenses. It could also make the Federal Reserve’s job of taming high inflation more difficult.

The U.S. central bank is trying to slow down economic growth to prevent inflation from becoming entrenched. To that end, it has increased rates aggressively this year and is likely to raise them another 0.75 percentage point at a two-day policy meeting that concludes Wednesday. That would bring the benchmark federal-funds rate to a range of 3.75% to 4%.

Some officials have argued for slowing the pace of rate rises after this week’s meeting. But the debate over the speed of increases could obscure a more important one around how high rates ultimately rise. In economic projections released at the Fed’s last meeting in mid-September, most officials anticipated their policy rate would reach at least 4.6% by early next year.

But some economists think it will have to go higher than 4.6%, citing in particular reduced sensitivity of spending to higher interest rates.

“The big question will be, given the resilience the economy has had to interest-rate increases so far, whether that will actually be sufficient,” said former Boston Fed President Eric Rosengren. “The risks are they’re going to have to do a bit more than they’re suggesting.”

The Fed combats inflation by slowing the economy through tighter financial conditions—such as higher borrowing costs and lower stock prices—which curb spending, further reducing employment, income and spending. This normally has its greatest effect on sectors of the economy most sensitive to the cost and availability of credit.

In 2020, however, the government’s wartime-like response to the pandemic—generous fiscal stimulus that showered cash on households and reduced borrowing costs—interrupted the usual recessionary dynamics of rising joblessness that amplifies declines in income and spending. It means private-sector balance sheets are in a historically strong position.

Household, non financial corporate and small-business sectors ran a surplus of total income over total spending equal to 1.1% of gross domestic product in the quarter of April to June, according to economists at Goldman Sachs Group Inc. Using a three-year average, the measure is healthier than on the eve of any U.S. recession since the 1950s.

U.S. households still have around $1.7 trillion in savings they accumulated through mid-2021 above and beyond what they would have saved if income and spending had grown in line with the pre pandemic economy, according to estimates by Fed economists. Around $350 billion in excess savings as of June were held by the lower half of the income distribution, or around $5,500 per household on average.

Businesses were also able to lock in lower borrowing costs as interest rates plumbed new lows in 2020 and 2021. Just 3% of junk bonds, or those issued by companies without investment-grade ratings, mature over the next year, and only 8% come due before 2025, according to Goldman Sachs.

State and local governments are also flush with cash, leaving them in a far better position than after the recession of 2007 to 2009.

While the housing market—among the most interest-rate sensitive parts of the economy—is entering a deep downturn, the rest of the economy is so far holding together. Consumer credit-card balances are rising. Earnings reports from companies including United Airlines Holdings Inc., Bank of America Corp., Nestlé SA, Coca-Cola Co. and Netflix Inc. also point to strong consumer demand and pricing increases.

“This is not the earnings season the [Fed] wanted to see,” said Samuel Rines, managing director at Corbu LLC, a market intelligence firm in Houston. “For now, the consumer is too strong for comfort.”

The Commerce Department reported Friday that consumer spending adjusted for inflation rose 0.3% in September from August, a pickup from prior months.

The upshot is that cooling the U.S. economy might require even higher interest rates. The household savings buffer “suggests to me we may have to keep at this for a while,” said Federal Reserve Bank of Kansas City President Esther George in a webinar earlier this month.

Ms. George is among a handful of Fed officials who have argued in favour of slowing down the pace of interest-rate increases. But she also said the central bank’s ultimate rate destination might be higher than anticipated and that the Fed might have to stay at that higher rate longer.

The tight labour market also figures into this calculus. It not only leads to higher wages that might bump up prices, but also could continue to power consumer spending even as households run down savings.

Worker pay and benefits continued to rise at a rapid clip in the third quarter, according to a Labor Department measure released Friday that is closely monitored by the Fed. The employment-cost index, a measure of what employers pay for wages and benefits, showed that wages and benefits for private-sector workers excluding incentive-paid occupations rose 5.6% from a year earlier.

Jason Furman, a Harvard economist who served as a top adviser to former President Obama, thinks it will be harder for the Fed to slow down the economy. He said he sees the fed-funds rate ultimately reaching 5.25% next year, with a significant risk for topping out at an even higher level.

Steven Blitz, chief U.S. economist at research firm TS Lombard, thinks the central bank’s policy rate will rise to 5.5%. “A recession is coming in 2023, but there is more work for the Fed to do to create one,” he said.

The silver lining might be that stronger private-sector balance sheets cushion the extent of any slump in the U.S. The danger is that higher interest rates or a stronger dollar make trouble in corners of a global financial system that had come to expect low interest rates to persist.

The idea of wallpaper elicits so much apprehension in homeowners, New York designer Francis Toumbakaris purposely uses the term “wallcovering” when speaking to clients about it. Yet decorating websites and media accounts teem with instances of the stuff. “It transforms a room and gives it personality,” said Casey Keasler, founder of design studio Casework, in Portland, Ore.

So what keeps folks from hanging the gorgeous material, and how do homeowners get over these wallpaper willies? Here, some case studies of conversions.

Hangup: It’s too pricey.

Budget concerns can hamstring homeowners. Home-services company Angi estimates that wallpaper can cost as much as $12 a square foot for labor and materials, while painting tops out at $6. “If the wall surface needs work beforehand, prices go up,” said Bethany Adams, an interior designer in Louisville, Ky. And Keasler notes that paper can cost as much as $400 a roll.

Antidote: Baby steps

New York designer Tara McCauley says homeowners can get more hang for their buck by using paper strategically. In an apartment in Brooklyn whose homeowners sweated the bottom line, she coated only the hallway with a dark-blue pattern inspired by Portuguese tiles. “It added so much impact,” McCauley said of the modest use. The designer adds that another way to save money is by hanging what she calls the gateway drug to wallpaper: patternless grass cloth. With no need to align a motif, the material goes up quickly and costs less to install, she says, “but it adds visual depth in a way plain paint never could.”

Hangup: I’ll get sick of it

A fear of commitment stops many would-be wall paperers, who worry about having a change of heart later. Erik Perez, a design publicist with his own firm in Los Angeles, campaigned hard for what he thought was the perfect old-Hollywood look for his and his husband’s dining room—a maximalist, leafy green wallpaper made famous by the mid-20th-century decoration of the Beverly Hills Hotel. His husband, Paul Hardoin, a voice-over actor, resisted. “Is it going to go out of style? Will I tire of it? Will it affect resale value?” he worried.

Erik Perez, right, and his husband, Paul Hardoin, in their Los Angeles dining room, clad in CW Stockwell’s Martinique paper. Photo: Julie Goldstone for WSJ

Antidote: Low-use spaces

Infrequently used rooms can carry a bold choice long-term. Of the Brooklyn hallway she wrapped in blue, McCauley noted, “It’s a pass-through, so you don’t get overwhelmed by a bold pattern.” Ditto powder and dining rooms, like that of Perez, who said, “We only used that room when we were entertaining and it was too cold to be outside.”

It took three years, but Hardoin caved when the banana-leaf pattern became available in blue. “I thought it looked cool,” Hardoin said. He took the leap, knowing his sister Annette Moran (a wallpaper enthusiast) would be their DIY installer. “Now it’s the happiest room in the house,” he said.

Hangup: It’s dated

When Sarah and Nate Simon bought a historic home in Louisville, Ky., the walls sported oppressively dark patterns, including big, repeating medallions set in a grid. Sarah recalls thinking, “ ‘Not this! What’s the opposite of this?’ In my mind that would be paint.” Even for folks who haven’t pulled down awful examples, “the word ‘wallpaper’ can take them back to flowery patterns of the ’50s and ’60s that feel very dated,” said Toumbakaris.

Antidote: Modernity

“Wallpaper does not mean what it used to. It can be meandering, abstract, ombre or sisal,” said Simon’s interior designer, Bethany Adams. She suggested a sophisticated Chinoiserie that New York designer Miles Redd, in a collaboration with Schumacher, updated with an aqua colorway. Adams explains that like most Chinoiseries, this pattern doesn’t repeat for more than 8 feet. “You get a peripatetic design that keeps the eye engaged,” she said. “It’s looser.” Said Simon of her dining room today, “It’s a complete transformation, like art on my walls.”

Stereotypes of fusty florals and pitiless patterns fall away when designers present homeowners with contemporary picks. Still, sometimes the conversion takes time. One of Keasler’s clients, gun-shy after removing old paper, came back a year later, ready. “We chose a clean classic style that was graphic and minimal for a modern edge in the bathroom,” said the designer.