News that the Federal Reserve will further delay the Fed Fund Rate increase seems worrying to economists who know the risks involved when nothing is done in business. During March’s Federal Open Market Committee (FOMC) meeting, they indicated the rate increases will further be delayed leaving the markets anticipating for a June and September rate hike. However, this timeline is greatly opposed by the Wells Fargo economists, Michael A. Brown and John E. Silvia, who understand the effects of such delays. Market reactors usually take additional risks when the interest rates are at their minimal. People will always search for high yields, making them take on more risks. According to the two economists, the Feds are behind the curve in the lifting the short time Feds Funds Rate.
Signs of risky behaviors have already been witnessed, and this is attributed to the easy monetary policies by the Feds. The rates have been kept low for the longest time possible, encouraging investors to take greater risks in search of high yields. Both Brown and Silva predict adverse economic risks if the Feds take too long before increasing the rates, and the high debt issuance will result in overheated credit sectors. This prediction is based on the dotcom bust in 2001, where the Feds rushed out and cut the lending rates to just 1 percent for a period of 18 months. The drastic decrease caused investors to react by taking greater risk, and increasing appetites for Non-QM mortgages. The effects of this could be seen in the price inflation on assets, as the economy experienced growths in the home mortgage sectors. The housing sector was most affected, since prices of homes were at a peak high.
Both Brown and Silva are cautioning the industry of similar challenges this year unless the Feds raise the rates soon. However, they do suggest the risks not only be focused on housing sectors, but instead on other areas of the economy. There is an already steady upward trajectory in the prices of the stock markets due to the low rates. Mergers and acquisitions (M&A’s) are on the rise since the last time they hit the bottom low in 2009. As of the quarter of 2014, M&A’s have already tripled, which is a worrying trend. Most of the M&A’s have been funded through the issuance of high risk yield debts taking place due to low Fed Fund Rates. Evidence has shown that the increased high yield risk taking is directly related to the monetary policies of a country. However, this phenomenon is not only in America. According to the Bank of International Settlement (BIS), there has been an increase in the new corporate debts, especially to lowly rated borrowers. The equity markets have also hit new heights with most asset values moving from basic fundamentals, showing a potential bubble indication.
Risk taking has moved to various financial firms with most lenders easing their restrictions. The asset based lending has become much easier nowadays, and much of this can be attributed to the increased values of assets. Generally, the long periods of low rates has created a higher risk behavior on both the supply and demand part. The Feds need to raise the rates sooner to avoid creating inflation in the market.
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