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Did the Federal Reserve Just Issue a Dire Warning for What’s Ahead? Lombardi Letter 2018-05-09 10:43:14 Even the Federal Reserve knows that rising interest rates could have dire consequences. With this, it's important for investors to keep a close eye on the derivatives market. Here’s the full story. Analysis and Predictions 2018,U.S. Dollar,U.S. Economy https://www.lombardiletter.com/wp-content/uploads/2018/05/iStock-905559456_cropped2-150x150.jpg

Did the Federal Reserve Just Issue a Dire Warning for What’s Ahead?

Did Fed Issue Dire Warning?

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Even the Federal Reserve Knows There Could Be Problems Ahead

The Federal Reserve is raising interest rates. This could lead to a lot of problems; even the Fed knows this.

You see, in the midst of the financial crisis, the Federal Reserve kept the interest rates near zero and kept on printing money. At that time, it was really needed. The Federal Reserve wanted to make sure that the U.S. financial system was strong once again and that the U.S. economy got back to its historical growth rates.

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The low rates and money-printing definitely helped the banks get their acts together. These interest rates boosted the stock market and maybe helped the U.S. economy a little (the economy is growing, but well below the historical growth rates).

But there was one problem: everyone got too comfortable with low-interest-rate policies by the Federal Reserve.

As it stands, not enough investors are asking what could happen as rates increase.

The Fed’s Dire Warning

With that said, if you ask the Federal Reserve, it is saying something that shouldn’t be overlooked. In fact, one could say that the Fed just issued a dire warning about the rising interest rates.

What is that warning?

At a financial conference in Zurich, Chairman of the Federal Reserve Jerome Powell said, “Some investors and institutions may not be well positioned for a rise in interest rates, even one that markets broadly anticipate. And, of course, future economic conditions may surprise us, as they often do.” (Source: “Fed’s Powell: Rate hikes should not upend the global economy,” CNBC, May 8, 2018.)

Don’t take this lightly. You don’t hear this sort of thing from the Federal Reserve often.

Putting it in simple words, the chairman of the Fed said that, despite everyone knowing that rates are going higher, some investors and institutions could struggle or may not be ready for it.

Mind you, it’s not just the Fed raising interest rates.

Rates are going higher in Canada and Britain is thinking along the same lines. The European Central Bank (ECB) has hinted that it is moving toward less printing and higher interest rates. Even the Bank of Japan, which has been printing and keeping rates below zero for years, has said that it might think about raising rates.

Don’t Ignore the Derivatives Market

Dear reader, with all this happening, I want to bring your attention to just one factor: the derivatives market.

At the end of 2017, American banks had derivatives that had a notional value of $172.0 trillion (not a misprint). (Source: “Quarterly Report on Bank Trading and Derivatives Activities, Fourth Quarter 2017,” Office of the Comptroller of the Currency, last accessed May 8, 2018.)

Out of the $172.0 trillion, $130.0 trillion was interest-rate derivatives.

Now, with even the Federal Reserve saying that not everyone is ready for rate hikes, one has to wonder what happens to these derivatives. The underlying amount of these derivatives is huge.

Remember, the financial crisis of 2008–2009 was caused by derivatives. Could the next one be because of derivatives as well? This time around, the catalyst could be the rising interest rates. Last time, it was the housing market.

In the meantime, don’t ignore what the Federal Reserve has just warned us about.

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