The Federal Reserve in the United States has decided to maintain interest rates at their highest level since before the global financial crisis of 2008-09. The Federal Funds rate stands at 5.25-5.5%, which is similar to the United Kingdom’s rate of 5.25%, while the European Union’s rate is at a record high of 4%. This decision is driven by persistent high inflation in the developed Western world, with some experts predicting that it could last for a decade or more. As a result, central banks are considering the possibility of higher rates that may last for an extended period.
This marks a significant departure from the past 15 years, where ultra-low interest rates have been the norm. These low rates were made possible by continuous borrowing at the government, corporate, and individual levels. This influx of money led to a strong and uniform rally after the global financial crisis and provided support to equity markets during the COVID-19 pandemic.
Investors are understandably concerned about the potential consequences of ending this regime. History has shown that capitalism is a cyclical game of booms and busts. Currently, we are at the beginning of a new cycle.
To understand the current situation, it is helpful to look back at the period between 1993 and 1995. During this time, U.S. interest rates rose rapidly due to a flash crash in 1989, high inflation, and tensions in the Middle East. Despite these challenges, the economy experienced a remarkable period of growth. The S&P 500 more than tripled in value, and the NASDAQ composite index rose by an astonishing 800%.
This period was characterized by globalization, innovation, and optimism, which led to the creation of the Internet, a backbone of the global economy today. However, this boom didn’t last, and by October 2002, the dot-com bubble burst, and the NASDAQ lost all its gains.
We find ourselves in a similar situation today, emerging from a period of high inflation and high interest rates amid rising tensions in Europe and the Middle East. Despite these challenges, the economy is performing well, even in the face of the COVID-19 pandemic.
There are also parallels between the dot-com boom of the 1990s and the rise of cryptocurrencies. In January, the approval of one or more U.S. Bitcoin spot ETFs is expected to attract significant institutional investment. This could trigger a wave of initial public offerings within and outside the industry, similar to what happened in 1999.
However, one key factor places us closer to the market cycle of 2001-07: debt. The reckless lending and trading practices during that period had a profound impact on the global economy. Today, we are seeing alarming signs of a similar situation, with record-high household debt in the U.S. and rising delinquency rates on credit card loans.
While this credit trend may not lead to a global banking crisis like in 2008, it is crucial for the health of the U.S. economy, which is currently driven by consumer spending. The longer interest rates remain high, the more pressure will build as debts continue to accumulate.
Another significant factor is the U.S. government’s debt, which has surpassed $30 trillion due to the pandemic. This unprecedented situation has led to credit downgrades for the world’s largest economy, which has been largely ignored so far.
However, we are not yet at a point of a “credit crunch” like in 2008. Despite signals from the bond market, the U.S. economy remains resilient, and consumer spending has not been deterred by higher interest rates. Wages are still rising faster than inflation, providing optimism in the markets, including the cryptocurrency market.
The odds are in favor of a strong bull market in the next year or two until it inevitably loses steam. Eventually, the massive debt burden of U.S. consumers will become unsustainable, especially if interest rates remain high for an extended period.
The U.S. Treasury and Federal Reserve will play crucial roles in this cycle. As we saw in March 2023, they are willing to adjust rules to ensure the survival of the banking system. However, the ups and downs of the market are inevitable.