The U.S. economy is in an extremely odd place. We are doing well; actually we are doing really well. Unemployment is currently 5.1% and the DJIA (Dow Jones Industrial Average) is around 17,000. Those numbers in 2009 were 10% and 6,600 respectively. Unemployment is halved and the stock market nearly tripled; what is the issue? The big issue is that interest rates are still 0%. The zero interest rate policy (ZIRP) is a tool used by central banks to stimulate an economy during the periods after a financial crisis. Low rates stimulate corporate borrowing and this money can be used to finance expansion, pay creditors, and most importantly create jobs. The population would have more money to spend, thus increasing consumption. Hopefully the cycle repeats itself thus stimulating economic growth. We have experienced growth, but the question is how much and for how long? The rates can’t stay low forever, because inflation will rise at some point and combined with a ZIRP could cause the dollar to go down in value. The low rates can also progress to a point that causes negative interest rates which cause banks to charge people to save their money. Investments in bonds would also be nonexistent. This is obviously the last thing that the Federal Reserve wants to happen. They are planning to raise rates by the end of the year. However, the economies of the world are so interconnected that the slightest change in other markets can have a substantial impact on the U.S.
Over the summer the DJIA hit 18,000. This new all time high had many economists and analysts optimistic about the future. It settled to a little over 17,000 but this was still a great sign for the market. The Fed was already discussing rate hikes, and this mark combined with more positive data, led people to believe that the fed would raise rates around September. In early August, however China decided to confirm speculation about their currency, the yuan, and devalue it. Over the next couple of days the stock market fell about 2000 points to around 15,000. Moreover, if companies’ share prices drop, they may cut cost and that means cutting jobs. Now was this downturn just a normal market correction in response to arguably overvalued stocks during the bull market of the summer? Were analysts just having cold feet because of China’s devaluation? Or was this a signal that the economy was to heading for a long term downturn and maybe a recession. All of these possibilities could point to the Fed possibly holding off on interest rate hikes.
Well, September passed and rates weren’t increased. The next Fed meeting will be held on October 28th. Word around the financial world is that they are still proposing to raise rates. The first proposed hike would only be to 0.25%, however markets are all about speculation. Wall Street is always trying to predict market swings and Fed decisions, and many analysts feel that the Fed won’t raise rates until next year. However, history shows that they have been wrong for the past ten years. This mistiming of forecasts could throw stocks completely out of swing, and cause stock markets all over the world to feel the impact. Emerging markets already have an uneasy feeling toward rate hikes. Investors have been taking more risks in less stable economies by seeking higher returns overseas. This new flow of money would gradually be moved back to the more stable U.S markets with the increased interest rates. The Fed needs to make a decision about the ZIRP. It could be behind closed doors tomorrow, it could be the morning of Oct. 28 right before the next Fed meeting. It justs needs to happen sooner rather than later. Economies wait for no one, especially government policy.