Are we heading for another financial crisis?

Try as it might, the Federal Reserve can't keep the coming crisis at bay forever.

"Talk about a mixed message," says The Wall Street Journal. Last week the US Federal Reserve dropped the word "patient" from its interest-rate outlook. Markets had expected the wording change, which was seen as heralding an interest-rate hike in June.

But Fed boss Janet Yellen indulged in so much "caution and hedging" in her press conference including a nod to the fact that the strengthening dollar had weakened export growth that investors decided a rate hike was further off than they'd thought. So they "indulged in another easy-money rally". We now might not see the first rate hike until the autumn at least.

Dammit Janet

While inflation is mildly negative, the idea that deflation is a danger because it paralyses economies is unconvincing, adds Gene Epstein in Barron's. Many economists fear that consumers will put off purchases. But "tell that to the thriving industries who are having no trouble getting customers to buy at flat or falling prices".

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More worryingly, asset prices are at eye-popping levels. US stocks are close to bubble territory. Bonds have long since reached it, as negative yields throughout developed markets illustrate.

However, it has been nine years since the Fed last raised rates. Debt levels are at historic highs. Central banks have given economies and markets unprecedented support via both zero interest rates and repeated doses of printed cash. Weaning them off this easy-money therapy might be harder than anyone imagines.

For example, last time around, the Fed's interest-rate hikes eventually "brought down the housing market" and triggered the financial crisis, says The Economist. Housing may not be an immediate problem mortgage payments now account for around 18% of household income, down from 28% in 2006.

Yet the "unobservable variable is confidence". How will dearer money "affect the animal spirits of investors and housebuyers? It is nine years since the last rise. Any change is a leap in the dark."

Another 1937?

On the other hand, at least it's clear how the Fed can squeeze out inflation if it takes off just raise rates. All this means it's riskier to move sooner rather than later, says Dalio. He points to 1937, when the Fed, thinking the US economy had finally shrugged off the Depression, tightened monetary policy. It set off a slide in housing and stockmarkets, battered confidence and ushered in recession.

Yet waiting to hike increases the risk of more damaging bubbles. Another blow-up in asset markets would batter financial institutions, and shock companiesand households into cutting spending.

"I don't think that real economy factors such as inflation or growth justify a tightening," says Gerard Minack's The Downunder Daily. But rates are too low for the financial economy, which is the tail that wags the dog these days.

Low rates "are encouraging financial smarty-pants to do the same sort of things that got economies into a jam in the first place". But it's probably already "too late to avert another crisis", says Albert Edwards of Societe Generale. "The financially fattened goose is well and truly cooked."

Andrew Van Sickle

Andrew is the editor of MoneyWeek magazine. He grew up in Vienna and studied at the University of St Andrews, where he gained a first-class MA in geography & international relations.

After graduating he began to contribute to the foreign page of The Week and soon afterwards joined MoneyWeek at its inception in October 2000. He helped Merryn Somerset Webb establish it as Britain’s best-selling financial magazine, contributing to every section of the publication and specialising in macroeconomics and stockmarkets, before going part-time.

His freelance projects have included a 2009 relaunch of The Pharma Letter, where he covered corporate news and political developments in the German pharmaceuticals market for two years, and a multiyear stint as deputy editor of the Barclays account at Redwood, a marketing agency.

Andrew has been editing MoneyWeek since 2018, and continues to specialise in investment and news in German-speaking countries owing to his fluent command of the language.