You've heard this a lot lately: The Federal Reserve is going to raise interest rates later this year.
Probably in June.
It sounds pretty simple. Chair Janet Yellen and her crew snap their fingers, borrowing costs rise and the world will move forward without a bump.
But it's not simple. In fact, there are a lot of potential unintended consequences when the Fed makes that simple move.
And I will tell you about six that I can think of without even straining my brain — just as soon as I make this caveat: When the appointed hour comes this summer or fall, I think the Fed will balk.
The economy just isn't doing that well — even after US financial data are gussied up to make it look like we have the prettiest economy on the planet.
So, what could happen if I'm wrong and the Fed is able to raise rates?
Well, I see the following bad things happening to the US economy should Yellen and Co. increase rates:
- Investors are going to lose a lot of money in the fixed income market. Medium-maturity government securities — say, two- to 10-year bonds — will go down in price. That's automatic. When rates go up, the value of bonds goes down. Also, anyone who's invested in "diversified" funds almost certainly has exposure to bonds. Money market accounts won't suffer as much because they mature quickly. And long-term bonds are a tougher call since the financial markets could ignore the dictates of the Fed. If Yellen decides to raise rates and predicts even more increases in the near future, longer bonds will definitely decline as well. Lots will be lost if that happens.
- Washington's deficit will go up if there's a rate hike. Not only will Uncle Sam have to pay more to borrow money in the open market but also the fake profits being turned over to the Treasury by the Fed will cease.
- Higher interest rates will make the bond market more attractive than stocks. Will this cause the stock market bubble to burst? It won't help.
- The value of the US dollar will rise some more. That'll be good for US tourists who want to travel to Europe (and aren't too afraid to do so) but it will hurt American tourism. And companies that do business overseas will have their profits pinched even more than they have already been.
- There are enough companies doing business overseas that overall profits and revenues for US businesses will decline. That will make price-to-earnings ratios in the US stock market — already elevated — go even more out of whack. This is bad news for Wall Street.
- Banks will use the Fed move as an excuse to charge borrowers more. And this will slow down the already anemic US economic growth. And if that slow growth is really being overstated by untrustworthy economic data coming out of Washington — as I've been suggesting — the Fed will inadvertently cause an already weak economy to become even weaker.
That is why a rate hike is not that simple.
Here's a news flash that should not surprise my readers: Researchers at the San Francisco Federal Reserve Bank say the Fed has been persistently too optimistic about the economy since 2007.
Wanna know why? One reason: The data the Fed is receiving are wrong.
Garbage in gets you a garbage forecast. Another reason: The Fed is deceiving itself because it likes to tell our politicians what they want to hear.
And University of Pennsylvania business professor Jeremy Siegel — known as "the wizard of Wharton" — said on CNBC the other day that "everyone talks about how very strong the employment reports are — the payroll reports. What they're not talking about is how amazingly weak the GDP growth is in light of this strong employment."
I think it's about time that Prof. Siegel and all the other rational economists who don't have a political agenda realize this: The employment data are wrong.
Job growth isn't nearly as strong as Washington is leading us to believe.
Prof. Siegel, start reading my column!
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