The FED took rates to zero on December 16th, 2008 and a short 7 years later on December 16th, 2015 rates leapt up to 0.25%. Classic economics teaches us how Central Banks can use monetary and fiscal policy to heat and cool the economies, and one of the major tools in that toolbox is through interest rates. Lower rates give borrowers an incentive to invest which stimulates growth, and when investment is too high, rates are increased to slow that growth, and in a nutshell the business cycle plays out.
According to the IMF, based on quarter-on-quarter changes to seasonally adjust real GDP, the Great Recession in the United States only officially lasted 12 months, from Q3-2008 unit Q2-2009. Most Americans would likely agree that the Great Recession lasted longer than 12 months, and some would argue that we have yet to get out of recession. Based on the FED rate policy it would seem with rates at zero that the FED felt the Great Recession lasted until December 15th, 2015 because it was the next day that the economy finally met the FED’s parameters after 7 years to support above zero rates.
To put words to the policy of the FED, rates were brought down during the Great Recession until they reached zero, and held at zero because the economy was too weak to support higher rates. Again, connecting the dots based on classic economic thinking, when the FED raised rates on December 16th, 2015, it marked the end of the Great Recession. Based on this logic the economy is not only healthy, but at a point were growth needs to be slowed down.
No matter your feeling on if the FED should or should not have raised rates, it is over (and all I got was this lousy t-shirt), and what do we say? That’s Right! The market hates uncertainty! The uncertainty is gone, rates were raised, end of discussion. Or is it?….
Again, based on what economics teaches us, the FED raises rates to cool the economy. If an economy is in a recession when rates are at zero, then when the FED raised rates on December 16th, 2015, did the FED just cool down a recession? The market hates uncertainty, and the FED’s actions just created two polar opposite conclusions that can be extracted from the rate hike.
One conclusion is that the Great Recession is over; the economy no longer needs the stimulus of zero rates. The conclusion is that the economy is strong, and raising rates will keep the economy from over-heating.
The opposite conclusion is that when rates are at zero the economy is fragile and by raising rates you just cooled a fragile economy.
The uncertainty of when the FED will hike rates now maybe gone, but based on these two opposite conclusions there is some serious head scratching still to be done by the market. It may be a bit of a “chicken and the egg” puzzle, but any-time rates are lowered it should be expected that once the desired results are achieved rates will be moved higher. Which brings us to the “million dollar question,” were the desired results achieved after seven years of interest rates at zero, or was a fragile economy just cooled?
The answer? Uncertainty, and again what do we say? The market hates uncertainty!
It does not matter if raising rates was right or wrong, what matters is that uncertainty remains. Removing opinion from the equation, as the FED preaches data dependency, and the data (though many argue that data is manipulated) shows that America is well past the depths of the Great Recession. The data would also show that many parts of the world are in, or are entering recession with two or more consecutive contractions to their quarter-on-quarter GDP.
We are living in an ever shrinking world, which begs the question how will changing American rates affect other economies around the world? Classic economics again teach us that the dollar will likely strengthen as rates rise. How will economies around the world that need to use stimulus to fight recession deal with the rising dollar? How will the bond market deal with these changes in the currency market and how will values of high yield bonds change as low risk yields increase? How will commodity demand change as these market changes take hold?
Though the question of when the FED would hike rates ended on December 16th, 2015, more questions now need to be answered. Did the FED mark the end of the Great Recession, or did the FED cool a fragile economy? How will the American economy and the world digest rates above zero after seven long years?
These questions and more will be answered soon enough, after all 2016 is here to answer all of our questions.