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Too late to back-pedal but too late in the cycle?

Published Tuesday, December 15th, 2015

The Fed begins its long awaited December meeting today and tomorrow is widely anticipated to announce its first interest rate rise in 10 years. Zero-interest rates are an emergency measure; the Fed is expected to declare that the emergency is over. A rate rise of 0.25% is priced in and investors are expected to turn their attention towards the speed and size of subsequent rate rises. However, there is an alternative view gaining ground which is that the Fed will be forced into a retreat next year. This view is based on the premise that the current post-financial crisis business cycle has lasted 78 months which is longer than 29 of the 33 economic expansions that have occurred in the US since 1854.

On this basis the interest rate increase is coming far too late in the business cycle and as a result there is at least a 50/50 chance that there will be a decrease rather than an additional increase next year in the face of a downturn. More alarmingly the last rate increase 10 years ago was from 5 to 5.25% which gave 525 points of stimulus potential to combat recession, which has been the case for the last three US recessions. Where is the headroom for the next recession which history tells us is due to commence in 2016?

Back to the here and now, the market is firmly of the opinion the Fed will raise rates tomorrow and has decided that if it does not that will imply a worrying lack of confidence in the US recovery. But, if the Fed proceeds, it will be in spite of tensions in the commodity markets, tensions in the junk bond markets, tensions in the currency markets and tensions in the equity markets. The environment for a rate rise is far from ideal and uncertainties may increase rather than decrease, whatever the Fed does.

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Posted by David Hufton