Is the Fed Being Forced To Raise Interest Rates?

The Federal Reserve is still on track to raise interest rates in 2016. Is this making sense given what is going on in the world right now? The economic numbers have indicated subpar growth for years now in most parts of the world. China has been issuing signals that their economy is not as good as it seems. The world equity markets were stalling before the meltdown of January 2016. Recently, the high yield bond markets are also showing signs of cracking. Many central banks have been lowering their benchmark lending rates to devalue their currencies. The US dollar is showing relative strength against most other currencies: This means U.S. exports are being discouraged. The inflation picture is officially very weak around the world including within the United States. The price of commodities has crashed throughout 2015 and into 2016, which is one of the large production inputs for almost every product made. On the financial side, the existing debt around the world is crippling and raising interest rates would be a catastrophe for borrowers. Would you raise interest rates given these factors?

The Federal Reserve may be raising interest rates for these reasons. The first one is that interest rates need to be normalized because savers are being punished and existing debt is excessive. This is not news – this effect on savers and borrowers has existed since the 2008 crisis. The second reason is that the zero interest rate policy was good, but it has gone too far. There has not been great growth since 2008 so the policy did not do what was expected. The third reason for raising rates is to undo the excessive leverage in the financial system. This was a known consequence of cheap interest rates – in fact this is why interest rates are a powerful tool that a central bank has to control the economy.

Could there be other reasons? Could a possible reason interest rates are rising is because the buyers of U.S. debt are dumping Treasury bonds in search of higher yields? Maybe the Federal Reserve is running out of buyers of its debt and it if does not entice investors in some way the debt cannot be refinanced? There is an expression in trading which states: “Don’t fight the tape” or “The trend is your friend”. If a tidal wave of dissention is building up and nobody wants your debt, something unorthodox has to be done. The real truth is that markets ultimately determine an interest rate – not central banks. The market will go along with a central bank until it does not want to.


About joetheinvestor
Joe Barbieri has Bachelors degrees in both Civil Engineering and Commerce from the University of Toronto. He has worked in the Financial Services field for over 12 years, covering positions from Retail Customer Service and Fund Accounting, through to Investment Research on the Institutional side. He has worked in 5 companies, spanning banks, a mutual fund, a Consulting Firm and a Large Canadian Pension Plan. He currently has a Chartered Financial Analyst designation (CFA) from the CFA Institute. He has recently published articles in Pension and Benefits Monitor Magazine as well as the Internet.

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