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Posts tagged ‘Interest rate hike’

Rates too heavy ?

Every heady bull run has excesses. From stocks being valued on eyeballs, junk bonds being rated AAA or NINJA ( no income no job no assets) loans being distributed by banks, these parties have seen them all. A notable common factor towards the latter phase of all these bull-run periods have been Fed interest rate hikes.

 

In fact a simplistic view of the situation could make a case that the Federal Reserve prompted the subsequent crashes through the interest rate hikes. Eventually, borrowers could not pay higher interest rates and defaulted or money stopped flowing into stock markets attracted by higher bond yields. It appears that this simplistic view is being taken seriously by none other than the Fed itself. This cannot be dismissed as mistakenly assuming correlation for causation.

The debt levels of today’s world are incomparable to those of earlier eras. Money is literally cheap today. Frighteningly, making it so does not bring inflation and growth. The interest rate hike announcements had been necessary for the Fed to signify that the economic situation was benign as dilly-dallying in the wake of supposedly strong employment and wage data would have been suspicious. Yet, it is impossible for it to deliver on its rate hike promises without precipitating a crash.

Earlier long-term bull-run phases had real earnings pick-ups which allowed the Federal Reserve to raise rates and rein in inflation. The markets did crash but only after years of growth. In any event, stock markets are cyclical. Now we are in an era of tepid growth and tepid inflation in much of the world. Corporate bond defaults are at multi-year highs as are student loan defaults. Yet, the S&P 500 has risen more than 200% since its ‘09 lows and is still rising. It’s a rally whose lifeblood is liquidity, something interest rate hikes are supposed to suck out. This is possible to achieve without immediate negative fallout during strong economic growth periods; this is certainly not the case today.

Regrettably, the Federal Reserve is in a situation where it cannot raise interest rates by more than a percent or thereabouts as it is painfully obvious that the heavily indebted businesses of today would not be able to afford much higher interest rates and neither can it hold firm forever as it would be giving live to its claim of a booming economy and a robust economic environment.

 

Imagine Janet Yellen trying to lift a big zero shaped boulder towards the sky. You get the picture. She is no Hercules.

P.S: Gordon Gekko said,” Greed is good.” Janet Yellen says, “Debt is good. ” We know how the movie ended.

 

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