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If you are wondering, where this is coming from? Then you might have noticed most of the reputed banks have failed back to back due to the bank’s operational efficiency and the indirect effect of the FED increasing the interest rates. FED has increased the interest rates by almost 9 times since March 2022 to tame the overheating situation of the economy – that is Inflation.
Addressing the situation, Elon Musk, the CEO of Tesla, Twitter, and SpaceX and the world’s second richest person, expressed his concern about a potential economic downturn if the Federal Reserve (FED) continues to raise interest rates. Musk stated that the economy could face a severe recession if the FED persists with rate hikes.
Why FED is increasing the interest rate?
If you know a little about the FED monetary policy, then you must know this. The action of the FED is a response to the situation of the economy. The adjustment of the interest rates is for reasons like maintaining the stability of the prices in the economy and keeping employment amplified.
The Federal Reserve adjusts interest rates upwards during periods of inflation and lowers them when unemployment rates are high. However, the Fed’s decisions can also be influenced by other economic challenges, and the above-said instance enhances the understanding of the concept. Nevertheless, the Federal Reserve’s dual mandate includes considering both inflation and employment when determining whether to raise or lower interest rates.
The federal funds rate is currently at 5 to 5.25 % although the agenda behind is to reduce inflation without igniting the recession but continuing to keep the interest rate higher can make borrowing costlier for both businesses & consumers and can as well weaken the economy.
The working of it is more like a pebble leaving a ripple effect in the water, meaning it trickles other interest rates. But with the fear of defiling the economy, it might not increase the interest rates that higher as well.
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Elon Musk’s opinion about the situation
He warns of a severe recession as the pile of banks is dead and it stresses the economy. This statement is coming from the data he has from the companies he runs, giving real-time insight into the distress it can cause due to tightening.
The interest rates are hiked by 475 basis points for over a year and can put the economy in a recession. He says it is currently mild and may go to its severity especially causing a significant impact on the banking sector. He says that considering the most recent failure of First Republic, Credit Suisse, Signature Bank & Silicon Valley.
Musk has written to FED more than 20 times about the recession stating the damage it could cause to the economy. And one such tweet stated, “Every time Fed raises rates, they’re increasing monthly payments for anything bought with debt.”
That’s true borrowing becomes costlier and the purchases may drop. Larry Summers, the Ex Treasury Secretary stated that the chances of recession are at 70% now leading to slowing economic growth combined with higher inflation.
The Psychology of Investors
What is it for investors?
As you may know, this is a crucial signal that an investor must look into. With the increased FED rates the bond yields are as well impacted and in turn, it can drop the bond prices, as you know with an increased interest rate, the prices of the bond fall as they have an inverse relationship between each other. The impact of this is seen on long-term bonds and hence in such cases holding a short-term bond seems more convenient and comfortable to avoid the interest rate risks.
Fixed Income Outlook – 2023
