What Risks Fed Rate Hikes Bring?
The US central bank has been raising interest rates gradually since late 2015, relying on steady economic growth. Still, it is less clear how rising rates might affect risk-taking in the "shadow" banking sector, where hedge funds and other less-regulated firms extend credit to riskier companies. In July, the Fed warned that borrowing among highly levered and lower-rated businesses remains elevated.
On the tenth anniversary of the 2008 financial crisis, which started with an unexpected panic in an under-appreciated corner of the financial sector, the emphasis in recent Fed speeches and research on avoiding excess leverage and financial market imbalances is understandable, but risks ignoring the possibility that the next recession may result from runaway inflation.
According to the Fed’s reports to Congress, the US central bank has highlighted concerns about commercial real estate and the stock market where rising prices could reverse sharply as interest rates rise.
Last week, the Federal Open Market Committee (FOMC) increases the fed funds rate 25 basis points to a range 2%-2.25%. The Federal Reserve also projects one more hike before the end of the year and three in 2019.
According to the latest Fed projections, gross domestic product will rise 3.1% in 2018, an upward revision from the 2.8% projection back in June. The forecast for 2019 also moved higher by 0.1% to 2.5 percent. The estimate for 2020 remained at 2%. The Fed also expects unemployment rate to hover between 3.5% and 3.7% through 2021, roughly a full percentage point below levels seen as consistent with a stable inflation rate.