After years of keeping the interest rate at near zero, the Fed is considering its first rate hike, causing traders and investors to freak out as they attempt to predict the timing and the how it will influence the market.
The massive plunge in stock markets in 2008 caused panic among investors, banks, and government, bringing back the fear that weak stocks would hinder consumer spending and force the country into another great depression, not seen since nearly a century before. This forced the central bank to react quickly to try and restore confidence in the market by facilitating trading with cuts to interest rates.
Within only a few months, the Federal Reserve had cut interest rates by 200 basis points, bringing it to an unprecedented near zero. The policy of zero interest-rate (ZIRP) is normally only used in extreme economic situations, and even then reversed almost straight away. However, nearly seven years later, the Fed is still keeping ZIRP alive and well.
The main consequence of ZIRP comes in the form of distorted financial markets, as prices are pushed up by easy money. The most visible effect is that U.S. corporations have now borrowed over a trillion dollars to take advantage of the low rates, and used the money to buy back their own stock in order to bolster the share price.
However, companies are not the only entities still taking advantage of near zero rates, as the U.S. government borrows money from the markets to insure uninterrupted service. This is nothing new, but ZIRP removed the usual high interest constraint on government borrowing, ushering a period of record government spending and the resulting deficit.
While the deficit has normalized in recent years, the debt still looms over the U.S. and the impending rate hike still creates a huge unknown as to its possible effects on the economy.