HH Will The Fed Initiate A (Mini) Crisis?
On paper, central banks are responsible for two things. They decide about the supply of currency and set interest rates. If the economy is healthy the velocity of money circulation grows higher creating inflation. Raising interest rates help to cool off the overheating economy. On the other hand, if the economy is heading for a recession central banks lower interest rates to make available to society credit cheaper and stimulate spending. This helps the economy get up from its knees. This is the theory.
Historically we see that central banks kept interest rates very low not to prevent economies from apathy but to create speculative bubbles and crashes that follow them. The control over economic cycles exercised with money supply and interest rates made it possible to transfer wealth out of the middle class to the financial sector.
Interest rates and the money supply were common tools to affect cycles until 2008 when after Lehman Brothers bankruptcy central banks panicked. The sheer scale of indebtedness on every level and vastly leveraged financial sector left the global monetary system crushed.
To avoid consequences of an uncontrolled crash, nearly every central bank on this planet lowered their interest rates to near zero levels. Just like they have done it in the past. This time was different. The fear over the financial system cohesion was and is so big that a rise in interest rates of more than 1% has not happened yet leaving markets addicted to ZIRP.
ZIRP and NIRP are here with us for 8 years already. Only one bank was brave enough to hike interest rates and it was the Federal Reserve of the US. American central bank was advertising their rate hike since mid-2014. Every quarter they found a new excuse of 'changing circumstances’ not to do it. After a year of stalling the Fed’s credibility was slowly disappearing because you can manipulate people for some time but not for long.
The first time, and the only one in the last 10 years, the Fed raised interest rates by 0.25% saving remnants of their face. The result was twofold. During the year before the hike USD gained over 20% vis-à-vis other currencies. Investors waiting for any upward movement of the rate moved their capital into the dollar consequentially it was strengthened. Finally when the hike was in we saw USD reaching its peaks.
In the past, in four out of five rounds of rate hikes, USD always made new records after the first hike. Later its price only fell lower. Only once dollar did not react at all. This is classic “buy the rumour, sell the facts” in its finest.
Secondly, prices of nearly all assets crumbled. Starting with equities, commodities and ending with precious metals. The beginning of this year was one of the worst in history. Despite the volatile reaction of market the Fed announced four hikes. I believed throughout the whole year that there is no chance for any interest rates to go up in the US and I had many reasons you got a chance to read about.