Best of the Week
Most Popular
1. Investing in a Bubble Mania Stock Market Trending Towards Financial Crisis 2.0 CRASH! - 9th Sep 21
2.Tech Stocks Bubble Valuations 2000 vs 2021 - 25th Sep 21
3.Stock Market FOMO Going into Crash Season - 8th Oct 21
4.Stock Market FOMO Hits September Brick Wall - Evergrande China's Lehman's Moment - 22nd Sep 21
5.Crypto Bubble BURSTS! BTC, ETH, XRP CRASH! NiceHash Seizes Funds on Account Halting ALL Withdrawals! - 19th May 21
6.How to Protect Your Self From a Stock Market CRASH / Bear Market? - 14th Oct 21
7.AI Stocks Portfolio Buying and Selling Levels Going Into Market Correction - 11th Oct 21
8.Why Silver Price Could Crash by 20%! - 5th Oct 21
9.Powell: Inflation Might Not Be Transitory, After All - 3rd Oct 21
10.Global Stock Markets Topped 60 Days Before the US Stocks Peaked - 23rd Sep 21
Last 7 days
Stock Maket Trading Lesson - How to REALLY Trade Markets - 26th Nov 21
SILVER Price Trend Analysis - 26th Nov 21
Federal Reserve Asks Americans to Eat Soy “Meat” for Thanksgiving - 26th Nov 21
Is the S&P 500 Topping or Just Consolidating? - 26th Nov 21
Is a Bigger Drop in Gold Price Just Around the Corner? - 26th Nov 21
Financial Stocks ETF Sector XLF Pullback Sets Up A New $43.60 Upside Target - 26th Nov 21
A Couple of Things to Think About Before Buying Shares - 25th Nov 21
UK Best Fixed Rate Tariff Deal is to NOT FIX Gas and Electric Energy Tariffs During Winter 2021-22 - 25th Nov 21
Stock Market Begins it's Year End Seasonal Santa Rally - 24th Nov 21
How Silver Can Conquer $50+ in 2022 - 24th Nov 21
Stock Market Betting on Hawkish Fed - 24th Nov 21
Stock Market Elliott Wave Trend Forecast - 24th Nov 21
Your once-a-year All-Access Financial Markets Analysis Pass - 24th Nov 21
Did Zillow’s $300 million flop prove me wrong? - 24th Nov 21
Now Malaysian Drivers Renew Their Kurnia Car Insurance Online With Fincrew.my - 24th Nov 21
Gold / Silver Ratio - 23rd Nov 21
Stock Market Sentiment Speaks: Can We Get To 5500SPX In 2022? But 4440SPX Comes First - 23rd Nov 21
A Month-to-month breakdown of how Much Money Individuals are Spending on Stocks - 23rd Nov 21
S&P 500: Rallying Tech Stocks vs. Plummeting Oil Stocks - 23rd Nov 21
Like the Latest Bond Flick, the US Dollar Has No Time to Die - 23rd Nov 21
Why BITCOIN NEW ALL TIME HIGH Changes EVERYTHING! - 22nd Nov 21
Cannabis ETF MJ Basing & Volatility Patterns - 22nd Nov 21
The Most Important Lesson Learned from this COVID Pandemic - 22nd Nov 21
Dow Stock Market Trend Analysis - 22nd Nov 21
UK Covid-19 Booster Jabs Moderna, Pfizer Are They Worth the Risk of Side effects, Illness? - 22nd Nov 21
US Dollar vs Yields vs Stock Market Trends - 20th Nov 21
Inflation Risk: Milton Friedman Would Buy Gold Right Now - 20th Nov 21
How to Determine if It’s Time for You to Outsource Your Packaging Requirements to a Contract Packer - 20th Nov 21
2 easy ways to play Facebook’s Metaverse Spending Spree - 20th Nov 21
Stock Market Margin Debt WARNING! - 19th Nov 21
Gold Mid-Tier Stocks Q3’21 Fundamentals - 19th Nov 21
Protect Your Wealth From PERMANENT Transitory Inflation - 19th Nov 21
Investors Expect High Inflation. Golden Inquisition Ahead? - 19th Nov 21
Will the Senate Confirm a Marxist to Oversee the U.S. Currency System? - 19th Nov 21
When Even Stock Market Bears Act Bullishly (What It May Mean) - 19th Nov 21
Chinese People do NOT Eat Dogs Newspeak - 18th Nov 21
CHINOBLE! Evergrande Reality Exposes China Fiction! - 18th Nov 21
Kondratieff Full-Season Stock Market Sector Rotation - 18th Nov 21
What Stock Market Trends Will Drive Through To 2022? - 18th Nov 21
How to Jump Start Your Motherboard Without a Power Button With Just a Screwdriver - 18th Nov 21
Bitcoin & Ethereum 2021 Trend - 18th Nov 21
FREE TRADE How to Get 2 FREE SHARES Fractional Investing Platform and ISA Specs - 18th Nov 21
Inflation Ain’t Transitory – But the Fed’s Credibility Is - 18th Nov 21
The real reason Facebook just went “all in” on the metaverse - 18th Nov 21
Biden Signs a Bill to Revive Infrastructure… and Gold! - 18th Nov 21
Silver vs US Dollar - 17th Nov 21
Silver Supply and Demand Balance - 17th Nov 21
Sentiment Speaks: This Stock Market Makes Absolutely No Sense - 17th Nov 21
Biden Spending to Build Back Stagflation - 17th Nov 21
Meshing Cryptocurrency Wealth Generation With Global Fiat Money Demise - 17th Nov 21
Dow Stock Market Trend Forecast Into Mid 2022 - 16th Nov 21
Stock Market Minor Cycle Correcting - 16th Nov 21
The INFLATION MEGA-TREND - Ripples of Deflation on an Ocean of Inflation! - 16th Nov 21

Market Oracle FREE Newsletter

How to Protect your Wealth by Investing in AI Tech Stocks

US Interest Rates - A Pound of Cure

Interest-Rates / US Interest Rates Sep 01, 2018 - 11:02 AM GMT

By: Peter_Schiff

Interest-Rates

This week, as investors and economists fixate on record highs set by major stock market indices, they have ignored much more significant developments that emerged from the Federal Reserve's annual meeting in Jackson Hole, Wyoming. Fed Chairman Jerome Powell delivered a speech that somehow was almost universally interpreted as a reiteration of his commitment to continue to raise rates throughout the next few years. "Steady as she goes" was the takeaway from just about any news outlet. But the Chairman's actual message was essentially the opposite of what the media reported. From my perspective, it provided evidence that President Trump has succeeded in getting Powell's mind right on the need for the Fed to continue to stimulate the economy, no matter how much evidence emerges that it is already over-stimulated.


Many reporters, undoubtedly eager to write a story that would cast Trump in a bad light, characterized Powell's speech as a courageous defiance to the President's increasingly strident calls for the central bank to end its tightening campaign. Some stories even jumped onto the current "people turning on Trump" narrative to showcase Trump's foolishness in having appointed someone who would so easily turn on him. I'm not sure what speech they were hearing.

Despite the fact that inflation has moved above the Fed's target 2% threshold (U.S. Dept. of Labor, Bureau of Labor Statistics News Release, 8/10/18), Powell repeatedly suggested that it isn't likely to remain there, and as a result, the Fed would be unwise to lean into a tightening policy as if it were. Instead, he argued that the Fed should pursue a "wait and see" attitude as long as possible, and should only move when the data is unmistakable. When the Fed does act, he suggested that bold and decisive moves would make up for prior restraint. Call this the "whites of their eyes" monetary policy: fire should be held until the last possible minute, and when the order to fire is given the intensity should be massive. (Someone should point out to Powell that we lost the Battle of Bunker Hill).

Powell peppered his speech with many cautionary tales of how the Fed erred in the past by fighting inflation that was never really that dangerous in the first place, and he praised former Fed Chair Alan Greenspan for not raising rates in the face of traditional inflation warnings. By focusing on the phantom menace of inflation, Powell suggested that the Fed cut off prior expansions prematurely. Instead, he advocated for a new doctrine that places less emphasis on prevention and more on reaction. In other words, why bother with an ounce of prevention when a pound of cure will do the trick.

While Powell did strongly suggest that he would deliver at least two more rate hikes in 2018, his outlook for 2019 became significantly less hawkish. In fact, based on my understanding, we should not expect any additional hikes in 2019. That means a 2.5% Fed Funds rate may be the highest we get in the current expansion. So despite the supposedly unprecedented strength of the U.S. economy, this cycle's peak in interest rates would be the lowest by far of any prior economic expansion. This thinking represents a significantly dovish shift in public Fed policy and should certainly play well in the White House.

But investors ignored Powell's words and continued to arrange their money as if the Fed's tightening bias remains firmly in place. In fact, this month the net short position in gold held collectively by hedge funds went positive for the first time since 2001. (Not insignificantly, this last occurred when gold traded below $300 per ounce and was on the verge of a six-fold increase over the next decade). This continued myth of a hawkish Fed has strengthened the dollar and punished gold, which earlier this month fell below $1,200 per ounce for the first time since the beginning of the year.

CNBC's Steve Liesman's Jackson Hole interviewed St. Louis Fed President James Bullard showcasing the Fed's thinking in even starker terms. Bullard suggested that the current Fed Funds rate of 2% is already far closer to normal than history would suggest. (In the past, a "normal" rate would be considered two percentage points above the rate of inflation). He claimed that since rates have been trending down since the 1980s, 2% today is not the same things as 2% in the 1990s. In other words, it's the new normal. He also said the Fed should take care not to invert the yield curve, which would suggest there is not much room to move rates higher in 2019, given his expectation that 10-year yields will remain below 3%.

Although this rhetoric sounds appealing, it forgets, perhaps intentionally, some key maxims that have guided Fed policy for generations. These include the idea that "the Fed should take away the punch bowl just as the party gets going" and perhaps more significantly, "once the inflation genie gets out of the bottle it's hard to put her back in." These ideas hint at just how much momentum gets built into a monetary policy and how hard it is to change course once things get out of hand.

The Fed's new strategy appears to be keeping the party raging by making sure the punch bowl remains spiked. If the inflation genie gets out of her bottle, Powell claims the Fed will "do whatever it takes" to put her back in. But there has always been a high degree of disagreement about when a bull market turns into a bubble. Usually, experts don't even agree until years later. So how can we expect the Fed to identify a bubble and react decisively, especially given the pushback it would get from investors and politicians for raining on the parade?

The same holds true for inflation, which tends to sneak up on central bankers unexpectedly. On several occasions in the 1970s and 1980s, inflation surged by 3 percentage points or more in one year. (New York Fed, "A Hisotry of Fed Leaders and Interest Rates", The NY Times, 12/16/15) If that were to occur again, could we really expect the Fed to react quickly and strongly enough to contain the outbreak? And how would the markets digest such a reaction? Recall that the Fed hasn't raised rates by more than a quarter of a percentage point at one time in more than 18 years. Drastic tightening moves have essentially gone the way of the Dodo Bird. If Powell thinks he could deal with a gathering inflation threat with a few quarter-point increases, he should take a few lessons in threat management. The metaphor of bringing a knife to a gunfight would apply.

Also bear in mind that there are many signs that the current bull market, already the longest in history, is reaching the end of its tether, even at a time when Fed policy remains undeniably easy. Firstly, there is the warning sign of dangerously tight yield spreads. Currently, the difference in yield between the 2-year Treasury bond and the 10-year Treasury bond is just .22%. (FRED, Federal Reserve Bank of St. Louis) This means that those lending money to the government for 10 years are only asking for .22% higher annual interest payments to compensate them for the eight extra years of commitment. This is the lowest gap since June of 2007. (FRED, Federal Reserve Bank of St. Louis) Narrow spreads between short and long-dated bonds are indicative of high economic fear and show that investors are valuing safety over risk. Generally speaking, the gap only gets to zero, or goes negative, when a recession begins. This could tell us that the very long 10-year economic expansion might also finally be nearing its end.

But this economic uncertainty is not happening against a backdrop of slowing inflation. On the contrary, inflation is finally starting to heat up and is now securely north of the Fed's 2.0% target, with year-over-year CPI rising at 2.9%, and year-over-year PPI rising at an even faster 3.3% clip. (U.S. Dept. of Labor, Bureau of Labor Statistics News Release, 8/9/18) This might indicate that the "stagflation" outcome of high inflation and slow growth is a much greater possibility than is currently believed. In such an environment could anyone really expect the Fed to "do whatever it takes" to head off inflation even while growth is sluggish? Could you imagine the crisis such a policy might cause? Talk about easier said than done!

But perhaps the biggest challenge the Fed could face in trying to put the inflation genie back in her bottle would be the problems it would create for the Federal government. The size of the rate hikes required to get in front of an accelerating inflation curve would cause the government's interest expense to surge catastrophically. Were this to happen during a recession (which such rate hikes could certainly precipitate), where already record-high budget deficits would be increasing, the fiscal shock could be devastating. Not only could the recession be intensified by restrictive monetary policy, but it might force an even greater dose of restrictive fiscal policy. The government would be left with three unappealing choices to fight inflation: Raise taxes, cut spending or default on Treasuries. (Since none of these solutions would be politically palatable, we should not expect any serious effort to fight inflation.)

If any of these remedies were actually attempted, they could create a severe economic contraction that could usher in a financial crisis far worse than 2008. All the "too big to fail banks" that are now much bigger than they were a decade ago could fail again. But if the Fed were serious about fighting inflation, it could not deliver the bailouts offered last time. Even depositors of failed banks may lose money as the FDIC would lack the funding to make them whole. This is precisely why the Fed may be all bark and no bite when it comes to fighting inflation after it becomes a problem.

The establishment will no doubt take solace in the belief that a recession will put out the inflation fire even if the Fed can't. However, high inflation is historically associated with economic weakness, not strength. If the next recession is accompanied by a falling dollar in the face of ballooning budget deficits, consumer prices could be expected to increase even as domestic demand falls. That is because domestic supply will fall faster as a collapsing dollar both chokes off imports and spurs exports. If the Fed ignores the inflation and instead accommodates those deficits with rate cuts and more QE, allowing the government to enact traditional Keynesian fiscal stimulus, the dollar decline may morph into a full-blown currency and sovereign debt crisis.

This will be checkmate for the Fed, and the end of a long road of can-kicking for the U.S. government. The long-playing music will have finally stopped, and the long-overdue day of reckoning will have finally arrived.

Read the original article at Euro Pacific Capital

Best Selling author Peter Schiff is the CEO and Chief Global Strategist of Euro Pacific Capital. His podcasts are available on The Peter Schiff Channel on Youtube.

Regards,
Peter Schiff

Euro Pacific Capital
http://www.europac.net/

Peter Schiff Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in