That is indeed the question when it comes to a potential interest rate hike next week.
There are wide expectations that rates will be raised. If so, the mechanics behind it would require up to $800 billion of collateral being pulled from the system to accommodate just a .25% rate hike. If the Federal Reserve tightens and collateral is removed, it must be added back from somewhere to prevent the whole system from “tanking” because everything is so leveraged.
Well, plans were that it would come from Europe via quantitative easing. The problem is that the EU governing council refused to let Mario Draghi ramp up the QE each month. The EU, led by Germany, wants to let some air out of the current bubbles so it has been refused. Draghi can say what he wants, but that is about it. That could jeopardize the entire system unless someone is willing to replace the collateral.
In essence, the Fed will be issuing a “margin call” into a system already lacking for liquidity. They originally treated a “solvency” problem with more liquidity. The problem with that is that it creates a far bigger solvency problem down the road. With a lack of liquidity, they no longer have the tools (collateral) to create needed additional liquidity. Even the BIS has warned the Fed about raising rates.
That’s the downside to raising rates. But raising rates is not negative to real estate, stocks, etc. in the current environment this time around. Why? You are not raising rates that are already high or above the rate of inflation. Instead you have historically low rates and deflation. A rate increase would be positive for real estate as it would trigger pent up demand in anticipation of further rate hikes. Long term, it will be beneficial to the stock market too.
Rising rates means the velocity of money turnover is improving with an increased demand for credit. That is a bullish fundamental for stocks. Same for commodities and gold, ultimately. Historically, many times gold has risen with rates too. Those are the economic “perks” of raising rates at this time.
Bottom line: I don’t envy Yellen, knowing the real risks accompanying a rate increase are not what we traditionally assume: death to real estate and the stock market, but an underlying risk of jeopardizing the entire financial system. Because of that, next week could be a volatile one in economically sensitive markets. I’d say our Fed is backed into a corner.