On Thursday the Federal Reserve Open Market Committee (Fed) may announce that it is raising interest rates for the first time in seven years. On the other hand, it might not.
The will it or won't it question has been Wall Street's obsession for months now, and it has spawned a wide variety of economic theories about what happens if the Fed, as expected, raises interest rates by one-quarter of a percent.
Theories range from the apocalyptic to the benign, and any number of smart, thoughtful people paint very different scenarios. So, what is the average consumer to think?
Stock market impact
First, raising interest rates is very likely to have a short-term negative impact on the stock market. That's because of the distorting effect cheap money has on stock valuations.
Think back to the housing bubble. A major reason home values soared as high as they did was because mortgage money to buy them was overly plentiful. Money wasn't exactly cheap but “creative” financing allowed buyers to purchase a home with low “teaser” rates for a couple of years before the rate reset to normal levels.
Current interest rates below 1% make it very cheap to buy stocks on margin, or in the case of corporations to buy back shares of their own companies to keep stock prices high. As a result, traders and investors could justify paying more for a stock than it's really worth, based on its fundamentals.
When rates go up it costs more to buy those shares, so the valuation has to be adjusted lower. That's what many economists expect will happen.
Shiller weighs in
Yale's Nobel economics laureate Robert Shiller has been outspoken in his concern that many stocks are currently overvalued.
“It looks to me a bit like a bubble again with essentially a tripling of stock prices since 2009 in just six years and at the same time people losing confidence in the valuation of the market,” Shiller told the Financial Times.
But Shiller is not one who is predicting a Fed interest rate hike will crash the stock market. He says the market has seen this coming for so long that it's really “no big deal” at this point. But at some point in the future, Shiller said he expects stock valuations to become more realistic, bringing prices down.
Mohamed El-Erian, chief economic advisor to Allianz, also believes the market holds some downside risk. But like Shiller, he thinks it could come from worsening economic conditions, rather than Fed policy.
But if stocks drop sharply in the months ahead, El-Erian told CNBC that he thinks it would be a “once in a decade” opportunity to buy bargain stocks.
So it sounds like the Fed raising rates might not cause lasting harm to the markets, but what about the economy?
In a media briefing late last week, Claudio Borio, an official of the Bank for International Settlements (BIS), noted that developing nation debt, in particular borrowing from the U.S., has surged since the financial crisis. But lately, credit has begun to dry up.
$3 trillion in debt
“The total amount of dollar credit to non-bank borrowers outside the United States had risen by over 50% since early 2009, to $9.6 trillion by the end of March 2015, and almost doubled for emerging market economies, to over $3 trillion,” Borio said.
Much of that money, he says, ended up going to foreign corporations that may, or may not, be able to pay it back.
That's why many international economists are urging the Fed not to raise interest rates just yet. The U.S. economy may be recovering and can withstand a modest hike – the rest of the world, however, might not.
In a global economy, the danger for the U.S. – and by extension U.S. consumers – is the threat that a global recession becomes a U.S. one as well.