Do lower interest rates in general lead to lower interest rates on credit cards? The answer is that the correlation between interest rates on credit cards and interest rates such as the Federal Funds Rate or the Prime Rate is low. For this reason, keeping short-term interest rates low does not spur credit card loan demand. That has implications both for monetary policy and for the fortunes of credit card lenders and their processing companies, such as VISA (NYSE:V) and MasterCard (NYSE:MA).
Lower interest rates, whether reflected buy the Prime Rate or by the Federal Funds Rate, do not appear to flow through to credit card rates. The differential between average credit card rates over the last 20 years, as computed by Evolution Finance, Inc., and the Prime Rate or the Federal Funds Rate, as computed by the author based on the Evolution Finance data and data from the Federal Reserve Board, exhibits significant variability. Here is a graph of the two differentials:
As can be seen, the Prime Rate and the Fed Funds Rate track each other pretty closely. The differential between either of those rates and the average credit card rate is not constant at all, varying by over 600 basis points, in either case.
Thus, it is not surprising that aggregate consumer revolving credit declined from September 2008 to October 2010 and has stayed about the same since then, despite low interest rates and gradual improvement of the economy.
Low interest rates do affect other forms of consumer credit, including car loans and home loans. But those sorts of purpose credit do not, except to the extent that refinancing at a lower interest rate spurs spending by freeing up consumer dollars, promote a higher general level of consumer demand.
For these reasons, we should not expect consumer borrowing to significantly improve consumer demand. In a way that is good, since high-interest-rate credit card debt is a poor way to finance a new dress or a vacation. But this conclusion suggests that wage growth is the only way that we should expect domestic consumer demand to increase. And if we think that wage growth is likely to remain subdued -- as I do -- then we have to look elsewhere than the American consumer for economic growth. With Europe stagnant (or worse), one asks whether the demand will come from Asia. Perhaps it will over the long term, but short-term, the signs are not encouraging. I also do not expect a great deal of stimulus spending (regardless of whether that would or would not be a good idea) to come from the U.S. government. Businesses spend only in response to their perception that demand (somewhere) is increasing.
Based on this line of reasoning, I have concluded that the economy, and therefore equities as well, are likely to remain fairly stagnant for some months. With that in mind, rather than sorting through my portfolio to figure out what to sell (though everything is, in principle, for sale every day), I recently bought some shares of ProShares UltraPro Short S&P500 (NYSEARCA:SPXU), a super-bearish ETF, as a hedge.
Disclosure: I am long SPXU.