Will the Fed’s Stubbornness Cause a Collapse?

us economy interest rates

In 2017, the US Federal Reserve has lifted interest rates twice. Stronger employment is their argument to end their decade long bond buying rampage. However, while employment in the US continues to strengthen, inflation remains stubbornly low.

This morning the US Federal Reserve held the federal funds rate on hold, below 1.25%. But they didn’t count out another interest rate rise, which would make it the third rate hike in 2017.

As reported by Bloomberg:

In the statement, the Fed set October for the start of their previously announced plan to shrink its $4.5 trillion balance sheet. As expected, policy makers left the benchmark interest rate unchanged in a range of 1 percent to 1.25 percent.

‘…Treasury prices fell and the dollar rose as investors weighed the Fed’s plans to press ahead with gradual policy tightening. U.S. stocks were little changed.

U.S. central bankers are counting on steady growth and low unemployment to raise inflation closer to their goal, which would support their policy of gradual tightening through interest-rate increases and a reversal of quantitative easing.

 

Higher Interest Rates?

I suspect the Fed wants higher interest rates so that, when the time comes, they can give the US economy another little kick. But to increase interest, the Fed will take to the bond market and start selling in bulk.

And if they start lifting rates too fast, they could cause real havoc in the bond market. This is a fear former Federal Reserve head, Alan Greenspan has. As he told Bloomberg on 1 August:

By any measure, real long-term interest rates are much too low and therefore unsustainable

When they move higher they are likely to move reasonably fast. We are experiencing a bubble, not in stock prices but in bond prices. This is not discounted in the marketplace.

While lower bond prices would pull up yields, they would also leave those who bought in when bonds were trading well above their par value, with a substantial loss. However I don’t believe it will come to this. The US economy is not as strong as the Fed thinks. And I believe it will keep interest rates low for the foreseeable future.

Regards,

Härje Ronngard,

Junior Analyst, Markets & Money

PS: Australia isn’t even hinting at higher interest rates. Economic growth isn’t where they need it to be, and debt is already crippling many Aussie households.

If you want to know how you can profit in a low interest rate environment, click here.

Härje Ronngard

Härje Ronngard

Harje Ronngard is a Junior Analyst at Markets and Money.

With an academic background in finance and investments, Harje knows how simple, yet difficult investing can be. He has worked with a range of assets classes, from futures to equities. But he’s found his niche in equity valuation.  

Härje Ronngard

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