While many economists are quick to declare that the U.S. economy has become immune to high interest rates, economist Jonathan Levin is telling them to hold their horses.

“It’s always worth treading carefully when folks tell you that the world has fundamentally changed forever,” Levin wrote in a Bloomberg column.

Levin’s remarks come as economists wonder if it’s time to redefine our expectations, given that sky-high interest rates have not been doing much to lower inflation lately.

A recent Federal Reserve Bank of New York survey found that most primary dealers now expect interest rates to settle around 3%, half a percentage point above the longstanding neutral Fed policy rate of 2.5%.

Meanwhile, options market traders are betting on rates staying at around 4% into at least 2026. Levin argues this is a "tectonic shift" in attitudes toward monetary forecasting.

“Market participants don’t just think rates will stay at their current extremes for longer than previously anticipated; they now also believe that rates may have to stay moderately high forever — a shift that implies far-reaching consequences for housing affordability, corporate finance and the national debt,” says Levin.

An economy that just won’t quit has many going back to the drawing board

Despite the Fed's highest rates in two decades, the U.S. economy expanded by about 2.5% last year, with low unemployment and near-record-high stock prices.

Some Fed officials say inflation could stretch into 2025, meaning a significant rate cut is becoming more and more elusive this year by the day.

This stubborn resiliency has led some to speculate that the economy may need permanently higher benchmark rates to prevent overheating.

Levin, however, cautions against embracing the idea that higher rates are here to stay, saying it misses “the particular and fast-changing circumstances of the current moment.”

Levin points to Treasuries to explain the current predicament

Levin explains in his column that the Fed's rate hikes haven't had as much impact as expected because long-term Treasury yields haven't increased as much as the short-term rates.

The 10-year Treasury yield is crucial because it directly influences borrowing costs for consumers and businesses, such as mortgage rates and corporate loans.

From March 2022 to July 2023, while the Fed raised rates significantly, 10-year Treasury yields only went up slightly. As a result, borrowing costs remained low, muting the Fed's efforts to cool the economy.

Levin calls this dynamic a "historical rarity" and that the yield curve will likely return to normal in time, albeit a little later than expected.

Those golden handcuffs are getting in the way, too

Levin also blames the "lock-in effect" as a significant factor in why recent rate hikes haven't hit the economy harder.

During the pandemic, consumers and businesses secured ultra-low fixed-rate loans, which many still have. However, time is ticking, so Levin contends this effect is temporary.

Businesses are already refinancing at higher rates, and mortgage rates on existing loans are starting to rise. As these changes take hold, the economy will likely feel the full impact of increased borrowing costs.

The key takeaway: don't jump to conclusions. Levin advises giving it time before overhauling our entire monetary policy expectations.

“We’ve just gone through an extraordinarily unique period in world history, and the economy is behaving in bizarre ways—but probably just for the time being,’ Levin says.