While the United States Federal Reserve opted to maintain interest rates at their November meeting, it is noteworthy that these rates remain at their highest level since well before the global financial crisis (GFC) of 2008-09. The Federal Funds rate currently stands at 5.25-5.5%, similar to the United Kingdom’s rate of 5.25%, while in the European Union, it has reached a record high of 4%.
The driving force behind this situation is the persistence of high inflation throughout the developed Western world. In fact, some experts, including Citadel’s Ken Griffin, predict that inflation will remain a significant concern for a decade or longer. Consequently, central banks are now considering the possibility of higher rates that may be sustained for an extended period.
This marks a considerable departure from the norm of the past 15 years, which featured ultra-low interest rates facilitated by continuous borrowing at the government, corporate, and individual levels. This continuous influx of money played a role in fueling a strong and uniform market rally following the GFC, and it also helped support equity markets during the unprecedented global health crisis of the last century.
Given these circumstances, it is understandable that investors feel apprehensive about the potential implications of the end of this regime. History has consistently shown that capitalism is marked by cycles of booms and busts, and it appears that we are now at the beginning of a fresh cycle.
While many predominantly look to the events of 2008 for insights into our current situation, it is also enlightening to consider developments from a slightly earlier period. Between 1993 and 1995, U.S. interest rates experienced a rapid increase due to factors such as a flash crash in 1989, high inflation, and tensions in the Middle East, all of which exerted pressure on the world’s largest economy. In response, the Federal Reserve raised rates from 3% in 1993 to 6% by 1995.
Contrary to expectations, this rise in interest rates did not harm the U.S. or its Western trading partners. Instead, it marked the beginning of a remarkable period of growth. Between 1995 and 1999, the S\&P 500 tripled in value, and the NASDAQ composite index soared by an astonishing 800%.
These years were characterized by globalization, innovation, and optimism, ultimately leading to the creation of the internet, which has since become not just the foundation of the global economy but an integral part of everyday life for people worldwide. However, this period of prosperity was not sustainable, and by October 2002, the dot-com bubble had burst, resulting in the NASDAQ relinquishing all of its gains.
At present, despite emerging from a challenging period of high inflation and interest rates, the economy is performing remarkably well, even amid rising tensions in Europe and the Middle East. It is worth noting the similarities between the dot-com boom and the current growth in the field of cryptocurrency. It is highly probable that January will bring the approval of one or more U.S. Bitcoin spot ETFs, leading to substantial institutional investment in this relatively new asset class. This development could potentially trigger a wave of IPO activity both within and outside the industry, potentially mirroring the dynamics of 1999 that eventually led to a market downturn.
While certain comparisons can be drawn between the present situation and the 1990s, there is a dominant factor that aligns us more closely with the market cycle of 2001-07, namely debt. The period of 2001-07 witnessed one of the most reckless eras of lending and speculative trading, which ultimately had significant global repercussions.
Today, concerning parallels indicative of the conditions leading up to 2008 are emerging. U.S. household debt has reached a record high, and delinquency rates on credit card loans are increasing at the fastest pace since 1991. Rather than tightening their belts, U.S. consumers have engaged in so-called “revenge spending” after prolonged periods of confinement due to the Covid-19 pandemic, and this behavior is taking its toll.
While the reversal of this credit trend may not pose a threat to the global banking system as it did in 2008, it is crucial for the well-being of the U.S. economy, which is currently heavily reliant on consumer activity. Moreover, the longer interest rates remain high, the greater the pressure will mount as accumulated debts continue to grow.
To address the significant issue at hand, it is important to note that the accumulation of debt is not limited to the U.S. consumer alone. The impact of the pandemic has caused the U.S. government to amass a debt amounting to over $30 trillion. This situation was previously unimaginable and has resulted in credit downgrades for the world’s largest economy, which, so far, has been underestimated.
However, it is crucial to highlight that we have not reached a critical turning point similar to the 2008 “credit crunch” just yet. Despite indications from the bond market, the U.S. economy remains resilient, including the U.S. consumer. Higher interest rates have not deterred individuals from buying property, and there is no inclination to reduce spending as wages continue to rise at a faster pace than inflation.
Furthermore, there is an air of optimism in various markets, particularly the cryptocurrency market. Investors are embracing altcoins, as evidenced by the recent surge in activity from Terraform Labs, Three Arrows Capital, Celsius, and FTX.
Taking into account these factors, there is a prevailing belief that a robust bull market will persist for the next one to two years until momentum fades away, as it inevitably does. However, it is important to acknowledge that the immense debt burden of U.S. consumers will eventually have consequences, especially if interest rates remain high over an extended period.
In navigating this cycle, the U.S. Treasury and Federal Reserve will play pivotal roles. As demonstrated in March 2023, they have shown a willingness to modify regulations to safeguard the banking system’s survival. As the situation becomes more unstable, it is likely that adjustments will be made. Nonetheless, it is crucial to remember that what goes up must come down. This is a certainty we can rely on.