On Wednesday, the Federal Reserve should raise its key rates, close to zero since 2008. Their previous rise dates from almost ten years ago
This is a historic decision. Some economists even speak of a revolution, with consequences as unpredictable as uncertain. Noting that the United States has returned to solid growth and full employment, the Federal Reserve (Fed) should, Wednesday, December 16, after a two-day meeting, raise its key rates.
They have been in the range of 0% to 0.25% since December 2008. The institution, created in 1913, had never let its interest rates so low for so long. Their last rise was on June 29, 2006, when Ben Bernanke, the president of the time, had raised them from 5% to 5.25%. “For markets, it was an eternity ago,” says Kim Schoenholtz, an economist at New York University. However, a large portion of traders, brokers and other market players today are hardly more than 30 years old. “They’re too young to remember how an economy with higher rates works,” says Gregori Volokhine, of broker Meeschaert in New York. For them, it will be a vertiginous leap into the unknown. ”
Disturbing weaknesses in the labor market
But this is not the only reason why the decision of December 16th is worrying. Unlike February 4, 1994, which had surprised the markets and panicked the stock markets, the rate hike this time was prepared and carefully announced by Janet Yellen, the current president of the Fed. But here it is: the global economy of 2015 does not have much to do with that before the crisis. Deflationary forces are pulling the industrialized countries. Despite full employment, the US labor market has troubling weaknesses.
To understand it, a step back is necessary. In mid-2007, the United States began to grasp the extent of the subprime crisis, a term given to mortgage loans granted by banks to thousands of poor American households. Loans that they then turned into financial products with barbaric names, such as ABS or CDO, which spread throughout the financial system.
Panic is spreading
As a result, when super-poor households start to stop paying their loans, panic spreads like wildfire. Who holds rotten ABS? Who is the weakest link? No longer trusting, financial institutions stop lending liquidity between them. At the risk of blocking the entire US economy. And by contagion, that of the rest of the world.
To avoid this, the Fed provides, from the end of 2007, the shortfall in liquidity to financial institutions, by short or long-term loans. But that’s not enough: on September 15, 2008, the bank Lehman Brothers went bankrupt. “At this point, Bernanke understands that if he does not act very quickly, the United States may plunge into a depression as devastating as that of 1929, which he is an expert,” says Kirkegaard. In November 2008, the Fed launched its first securities buyback program, quantitative easing, or “QE”. It buys banks mortgage loans that no one wants, to restore confidence. And it lowers the key rates to zero.
It works. By 2009, the country is coming out of recession. The institution then faces a major challenge: how to continue to support the economy now that its rates, its main weapon to boost credit and activity, are at the bottom? “To achieve this, Mr. Bernanke deploys new and daring tools, ” says Alexandra Estiot, BNP Paribas. Starting with two new EQs, in 2010 and 2012, concentrated this time on public debt repurchases. What provide additional liquidity to the system, support prices and lower the cost of borrowing for businesses. These operations inflate the Fed’s balance sheet from 845 billion euros in early 2008 to 4,045 billion euros in 2014 or 24% of gross domestic product (GDP). Never seen.
Result? “For the most part, the Fed has achieved its objective: it has avoided the 1929 scenario, boosted growth and brought the country back to full employment,” said Eric Chaney, at Axa IM. Some experts nevertheless point out that the billions of liquidity injected into the financial system have fueled an excessive rise in equities. Even, the formation of bubbles. “Only the richest households have benefited, which has contributed to widening inequalities,” adds Stéphanie Villers, chief economist of Humanis. Not to mention the collateral effects on emerging countries, whose currencies waver every time these shifting liquidities invest or leave their stock exchanges …
Suffice to say that Ms. Yellen’s mission promises to be delicate. It will have to raise rates very gradually so as not to weaken the US economy while ensuring not to fuel bubbles. It will also wean the markets, addicted to monetary largesse for so long that they can not do without it. The rehab is going to be painful.