I hate preachers of doom and destruction. I think most of them just want some attention, and instilling fear into people’s minds works better in doing so than painting a rosy future. But something quite concerning recently caught my attention, and – even though you might have already noticed it – I want to point it out.
Governments worldwide decreased interest rates in response to the 2007-2008 financial crisis. The idea was that by decreasing the interest rate, it becomes cheaper for banks (hence people) to borrow, hence increasing the amount of money available to spend, thereby increasing the spending power of the economy.
As a matter of fact, the USA has had such a ‘stimulating’ economic policy for over 30 years to date. If you look at the United States Fed Funds rate, the main determinant of interest rates in the USA, you can clearly detect a down-trend since 1980:
This policy has shown to be effective, at least in recent years. The unemployment rate in the USA has decreased from 10% in 2010 to around 5% in 2016. This might be a case of post hoc ergo procter hoc, but it seems hard to believe that the US stimulating policy has had zero positive impact on the economy. Furthermore, if you take the S&P 500 index to be the benchmark of the US stock market, you see that it has tripled since the bottom of the financial crisis in 2009; from 700 to 2100. In fact: the S&P 500 index has been in a clear up-trend over the course of the last 30 years:
You see the relationship? What we see here is a clear negative correlation between the Fed Funds rate and the S&P 500 index. The first question you should of course ask yourself when talking about correlations is: are the increasing stock prices a result of the decreasing interest rate, or is the deceasing interest rate a result of the increasing stock prices? The last relation seems to make no sense, for if anything, a higher stock market might be a symptom of a market overheating, hence encouraging restrictive instead of stimulating economic policy. So the relation seems to hold the other way: a lower Fed Funds rate causes the market to increase, which from a perspective of common sense, seems to make sense: lower interest rates means more money to spend, means more money to spend on stocks, means higher stock prices.
But the question that nowadays is very relevant is: what will happen to the stock market when the US government decreases its stimulatory policy? That is: what if the down-trend in the Fed funds rate stops? Currently the Fed has an overnight interest rate between 0.25%-0.50%, which is already higher than the 0.00% it has had for over 6 years. Now it is considering to increase it. It seems fair to say that we can not go lower than 0.00% (although this has been done in Europe, but following up on this policy will lead to all sorts problem for the banking sector, not to mention a slippery slope). Hence the Fed funds rate can only go up. Given the negative correlation with the S&P 500 index, which is based on 30 years of economic data, there seems only one way for the US market to go, and it is not up.