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Fed’s Rate Hikes and The Unintended Consequences on U.S. Debt

With the Federal Reserve’s recent rate hikes, we’ve seen bond yields spike, the housing market takes a hit, and commercial real estate is thrown into a tizzy. But if you were to ask Barry Sternlicht, the billionaire CEO of Starwood Capital Group, he’d tell you that there’s an even bigger player feeling the pinch: the US government.

Here’s the crux: “Imagine having to cough up interest for a $33 trillion debt at 5%. That’s the reality the federal government is grappling with,” Sternlicht highlighted at the Future Investment Initiative in Saudi Arabia. And for a bit of context, this jump in the fed funds rate—from a measly 0.08% to a whopping 5.33% since March 2022—is the most rapid in the last four decades. Sternlicht’s prognosis? Rates will likely have to drop.

His rationale? Sternlicht believes it’s almost a catch-22. “If you think Western democracies can sustain such high rates, think again. The cycle is vicious—printing more money just to cover the interest expenses, widening deficits,” he explained. And that’s not all. Some financial aficionados are ringing alarm bells, suggesting the rate hikes could lead to a dismal scenario where investors might balk at US government debt. This apprehension has further been fueled by America’s credit rating taking a hit this year, as cited by Fitch Ratings. Suddenly, the once rock-solid Treasurys are looking a tad shaky.

Now, for those drawing parallels to the 1980s when the Fed made similarly aggressive rate moves, Sternlicht offers a fresh perspective. “Back in the day, Paul Volcker—the Fed chairman known to be Jerome Powell’s North Star—was dealing with a $200 billion deficit. Today’s $33 trillion? It’s a whole new ball game,” he emphasized.

But what’s driving this towering US debt? Sternlicht points towards the mega fiscal stimulus packages rolled out in recent times. Think of President Biden’s economy-boosting strategies, including the CHIPS Act (a shot in the arm for domestic semiconductor production), the Inflation Reduction Act, and the Infrastructure Bill—all translating to copious government expenditure.

So, what’s the ripple effect? On one side, these financial shots of adrenaline are keeping the US economy afloat. On the flip side, higher rates mean businesses are shelling out more for borrowing. Sternlicht paints the picture as a fiscal tug-of-war: “The government’s spending spree is on a collision course with the private sector, which is reeling from these steep interest rates. The aftermath? Potential inflation. For instance, the housing sector is stalling, as no one’s eager to build with interest rates skyrocketing.”

For entrepreneurs and investors, this is a narrative to watch closely. It’s a delicate balance of fiscal policies, market dynamics, and global economic pressures. As the story unfolds, one thing is certain—the next chapters in the US economy’s storybook are bound to be riveting.