The US Fed is in a catch-22 situation

Mon, 14 Sep Pre-Open

   Previous Close   

   09:30 am   

   11:30 am   

   01:30 pm   

   Closing   

September 2015 has turned out to be a tumultuous month for the markets. The main concern is the decision by the US Fed about a possible interest rate hike. They could take this decision on the 17th of this month. Whatever the Fed does, it will have far reaching consequences.

As it may be a major market event, a little perspective is in order. US interest rates have been near zero since the global financial crisis of 2008. Nearly seven years have passed. In the meantime, a massive amount of money was pumped in by the Fed via QE. The Fed's balance sheet has ballooned to about US$ 4.5 trillion today. In fact, the last rate hike by the Fed was about 9 years ago!

So much cheap credit over such a long period should have done its job. The US economy should have come roaring back from the depths of the 2008 crisis. But that is not what has happened. Banks did not use the easy money conditions to give out loans. The reason? They did not find too many credit-worthy borrowers. US businesses too could not find many profitable investments. At the same time, US consumers took cut back on their debt fueled spending. Consequently, the US economic growth has remained tepid.

More than six years in to the so called 'recovery', the US Fed faces a catch-22 situation. They have stated publicly that interest rates should probably rise this year. However, the chances of a 0.25% rate hike on the 17th are about 50-50 we believe.

The Fed is in an unenviable position. Their policies are largely responsible for the rise in US asset prices. At the same time, they are aware that the recovery is fragile. If they raise rates, this weak recovery could be threatened. However, if they don't raise rates they risk their own credibility.

They will have to bite the bullet sooner rather than later. September 17th could be the day that the US interest rate hike cycle restarts. If so, expect turbulence in global markets. Whatever the impact of this minor rate hike on the US economy may be, market sentiment could take a big hit.

However, long term investors need not lose sleep. It is exactly such events that provide opportunities to buy great businesses at good prices. If the Indian markets were to fall significantly due to this event, we at Equitymaster will be quite happy to recommend solid stocks for the long term.