Rate Hike and Junk Bond Worries – 12/15/15

As the Federal Reserve prepares to rise the benchmark short-term interest rate from zero in its first rate hike since the financial crisis, analysts are closely watching for signs of weakness that could cause a reversal.

The Summer slowdown in the Chinese economy combined with below target inflation had made the Fed reluctant to make the rate hike earlier in the year but the robustness of American growth in the face of such issues abroad has inspired some degree of confidence. At this point, businesses have long been prepared for the increases so another delay would only bring doubt to a market better served by predictable regulation. Even so, the US economy has been growing for over half a decade and, as in every business cycle, the further away from the last crash we go, the closer we get to the next. Asset bubbles are taking shape constantly and any one of them could force reversals over fear of fizzling growth. On the other hand, if the Fed does nothing, then the interest rate will no longer be a tool it can use to boost growth unless it runs rates negative.

The threat of a destabilizing run on debt markets is looming. As oil-prices continue to disappoint companies and investors, junk bonds drag down performance of the funds holding them. Many seeking an out sell what they can to meet the earliest out calls leaving those who remain with less liquidity and greater to desire to exit. As a result, demand for riskier assets has dropped dramatically and many fear that the market will begin to freeze up and the economy as a whole will start a new decline. The state of global junk-bond markets and commodity prices have driven down stock markets across most nations as investor confidence has dipped. Oil-and-gas and mining sectors are posting the losses causing markets to stumble and risk premiums to rise. And pessimism due to oversupply and warm weather has led many fund managers to bet against a near-term revival in oil and gas prices.

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