NAIROBI (CoinChapter.com) — The United States financial markets continue to thrive despite the Federal Reserve’s extended policy of holding interest rates at 23-year highs. The central bank’s decision to keep the policy rate at 5.25% to 5.5% for over a year has not led to the typical systemic problems seen in past economic cycles.
Let’s discuss three key reasons why the U.S. financial markets are performing well under these conditions.
Privatization of Risk in U.S. Financial Markets
The Federal Reserve’s prolonged hold on interest rates has encouraged private entities to assume more financial risks. This shift is evident as private firms and investors increasingly venture into high-yield bonds and private credit markets.
In Q1 2024, U.S. high-yield bond issuance issuance surged to $68.6 billion, nearly double the $35.2 billion raised in Q1 2023 and more than double the $33.4 billion recorded in Q4 2023. This strong performance underscores investors’ appetite for higher returns in a low-rate environment.
Unlike the tech stock crash in 2000 and the subprime mortgage crisis in 2007, today’s financing increasingly comes from private markets. Pension funds, endowments, family offices, and ultra-wealthy individuals are more directly involved in lending through non-bank institutions.
This shift means problems in private credit markets are less likely to cause widespread panic. Missed payments are not publicized, avoiding the herd-like behavior of investors. The International Monetary Fund (IMF) has highlighted the potential risks, noting the lack of transparency and the potential for lower underwriting standards. However, the reduced risk of sudden funding stops provides stability.
Government Debt Powers Growth in U.S. Financial Markets
Historically, corporate and household debt binges have precipitated economic downturns.
This time, however, the Fed balance sheet has taken center stage, contributing its highest share to GDP growth in over a decade—99% of the U.S. GDP, according to the Congressional Budget Office. This leveraging of the Fed balance sheet is inherently less risky than private sector borrowing sprees.
However, there are concerns about the sustainability of rising debt levels. Seth Carpenter, chief global economist at Morgan Stanley, notes that while there may be a limit to how much debt can be issued without increasing yields, the U.S. has not yet reached that tipping point.
The strategic use of government debt has powered growth without the same risks associated with private sector leverage.
Fed’s Strategic Risk Balancing
The Federal Reserve carefully balances risks to maintain stability in US financial markets. Despite aggressive interest rate hikes and reducing its bond portfolio, the Fed remains alert to potential downside risks. The central bank provided emergency funding during the collapse of Silicon Valley Bank in March 2023, demonstrating its commitment to avoiding a financial crisis.
The Federal Reserve has carefully balanced risks to maintain economic stability. Despite the aggressive interest rate hikes and reduction of its bond portfolio, the Fed has remained alert to potential downside risks. The central bank provided emergency funding during the collapse of Silicon Valley Bank in March 2023, demonstrating its commitment to avoiding a financial crisis.
Fed Chair Jerome Powell and his team have effectively removed further rate hikes from consideration, focusing on maintaining a strong economy and controlling inflation. This cautious approach has limited market volatility and contributed to easing financial conditions. However, high interest rates for an extended period can still cause stress, particularly in areas with less visibility, such as lending to low-income households by fintech firms.
The U.S. financial markets are successfully navigating the long Fed hold due to the privatization of risk, government debt-driven growth, and strategic risk management by the Federal Reserve. These factors have helped maintain stability and prevent the systemic problems seen in past economic cycles. However, ongoing vigilance is necessary to address potential risks and ensure continued economic health.
