Last Friday, the Federal Reserve lowered the discount rate in response to the subprime crisis that lead to the global credit crunch, which severely affected the markets and most exchange traded funds (ETFs). The goal in this was to avoid further deterioration in the financial system. However, if the Fed were to take further action by cutting rates again and injecting more cash, it could lead to another asset bubble in the emerging markets, say John Hughes and Scott Maragioglio for Here’s how they say it could happen:

In 1997-98 the Asian crisis led the Fed to cut rates and add liquidity to stabilize the economy. It worked, but eventually the excess liquidity created the technology bubble that burst in 2001. When the tech bubble popped, the Fed again was sent to the rescue to lower rates and inject cash into the U.S. banking systems. Again, this worked, but eventually the housing bubble blew up, which leads us back to last Friday. So where will the next bubble be created?

The Emerging-markets arena seems to be a likely candidate because investors rarely pump up a sector that was in a previous bubble. Emerging markets already are exciting and full of promise. So with a little extra liquidity in the economy now, we’ll have to wait and see if the emerging markets, such as the iShares MSCI Emerging Markets Index (EEM), swell rapidly.

The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.