Why the Fed Rate Cut Will Inflate the Stock Bubble – And Cause It To Pop

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The Fed is using low interest rates to prop up the stock market again. This is why the stimulus party will not last. | Image: Bryan R. Smith / AFP

  • The Federal Reserve made a surprise emergency cut of 50 basis points in the federal funds rate on Tuesday in a desperate attempt to reduce the impact of coronavirus <. li> The rate cut will not solve all the problems; we do not know to what extent the coronavirus hurt the global economy.
  • The stocks are too expensive. The rate cut by the Fed could further inflate the bubble.

    On the morning of Tuesday, the Federal Reserve reduced the federal funds rate of half a percentage point to help protect the economy from the effects coronavirus.

    When the economy is slowing, reducing the federal funds rate is a tool uses the central bank to stimulate economic activity. Consumers and businesses spend and invest more, which in turn will increase stock prices.

    The interest rate reference is 1% to 1.25%. This is the first rate cute emergency since the financial crisis of 2008 and the biggest cut since. Advertising

    The rate cut follows a meeting of the G-7, where the group has agreed to use policy tools at their disposal, but took no specific measures to combat COVID-19.

    investors were surprised when the Fed cut rates on Tuesday. U. S. stocks rose after the announcement, but began to plunge back an hour later. Markets would rally again on Wednesday, with the Dow gaining nearly 1,200 points.

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    While this rate cut might seem like a positive thing at first, it is not clear if conventional policy tools can fight a disease like coronavirus. At the same time, the rate cut is likely to inflate the stock market bubble, because it encourages investors to buy more shares, which can lead to burst.

    Last week, the markets dropped sharply, leading to more reasonable levels. But the increase in reserves we saw on Monday and Wednesday pumped back bubble, which will appear one day - the question is when rate cuts the Fed could pump the highest populations of new highs .. | Source: Twitter rates

    of interest have remained low over the past decade. For investors interested in income, lower rates will mean less money in their savings. bills and bonds of newly issued Treasury will also have lower rates. It is tempting for investors to move their money into the stock market where they can find stocks that pay high dividends.

    The REIT telecommunications sectors and are particularly attractive because they usually have yields higher dividends than other sectors. So whenever the Fed cuts rates, investors are buying more shares, increasing its prices and thus inflate the bubble.

    The lowest average rates companies also can borrow at a cheaper cost, which helps them grow. This should be positive for future earnings, leading to their highest values. So investors buy more of these actions.

    With all cuts, the Fed has created a bubble. Despite warning signs as trade wars, international tensions, political chaos in the US and weak economies in other parts of the world, the market ignored them and continued to climb. Advertising

    Nobel-winning economist Robert Shiller of the award has developed Ratio cyclically adjusted price-earnings (CAPE ratio), or Shiller PE ratio to assess how the market is expensive. During Black Friday, the place was about 30. This ratio reached almost 35 just before the market crashed last week.

    The CABO ratio is now about 30, about 70% higher than the historical average of 17. Thus., The market is clearly too expensive relationship Shiller PE indicates that the market is very expensive | Source: multpl.com

    lower interest rates and consumers promptly businesses to increase not only their investments and their costs because they can borrow at a lower cost. Overspending has led to record U. S. household debt, now reaching $ 14 trillion. Reducing interest rates could encourage consumers to take on more debt could become unsustainable at some point.

    coronavirus impact could be worse than we expect

    The coronavirus is expanding rapidly, and we have no idea how much it will hurt the global economy. rate cuts can not eliminate the virus and all the problems it is causing.

    If US companies can not get the products and materials from other countries, and if they can not sell their products worldwide because of restrictions imposed because of the virus, will lose money.

    Goldman Sachs predicts that the coronavirus could end profit growth and that companies will not bring any benefit earnings for the year.

    Since the Fed is cutting rates now have less room to cut rates later, at a point lower financing costs could grow really help businesses.

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