Tag Archives: Fed Rate

Current Events

Federal Reserve

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Another good one from Marine Greg.  As you read this, remember a couple of things. One is the economic definition of inflation in layman’s terms: “Too much money chasing too few goods.” And secondly, one of the truisms I learned in Econ 101 is: Put five Economists in a room and ask them a question, and you will get six answers, all different. Why is that? Because Economics is a social science, not a hard science

 

A Binging Pivot                                                                      By: Greg Maresca

It was one of the most anticipated announcements of Joe Biden’s presidency that was nearly on par with him dropping out of the presidential race and fading to irrelevance.

For the first time since 2020, the Federal Reserve cut interest rates by half a percentage point making the range between 4.75% and 5% with anticipation of more to come.

“The U.S. economy is basically fine,” claimed the chairman of the Federal Reserve, Jerome Powell, who made the cut regardless and seemed unconvinced about anything else. To no surprise, the stock market approved following up with record highs.

When deciding on rates, The Fed has always been a reactionary institution that relies on historical data and models like the Phillips curve that was debunked two generations ago. Cutting rates will grow the money supply and bring some relief from higher interest rates. The Fed is putting pressure on inflation to bring down interest rates as the way to manage our exploding deficits.

The rate cut will only fuel inflation – an unwritten and unrestricted tax on everyone – no exceptions.

The interest rate was at a historical average, but the national financial sector and the Washington bureaucratic swamp are addicted to cheap money that makes $50,000 cars and $300,000 homes seem affordable. Over time this money infusion will make those cars and houses even pricier. Believing cheap money is the driving force of economic prosperity is as counterfeit as they come. Such behavior increases demand without an increase in supply – the root cause of inflation. Keep in mind that both food and fuel are excluded from inflation calculations.  This, my friends, is unknown to most Americans. Should food and fuel be added to the inflation number, you would be shocked.

Interest rates are The Fed’s dependent drug.

“When is the next cut coming and how big?”

A half of a percent reduction suggests the economy and its capacity for job creation is not nearly as good as Powell or any other entrenched government bureaucrat will admit.

There was no need for the cut, but lower rates produce lower mortgages and pacifies the masses making them feel better about the current political and economic situation.

The Fed, “a nonpartisan agency,” put its thumb on the scale during a presidential campaign begging the question: Is The Fed an impartial and independent agency or beholden to politics and Wall Street? Lowering rates at the expense of higher inflation seems self-serving in the run up to a presidential election that is less than six weeks away.

Powell, who served as carnival barker for the Biden administration’s highest inflation rates in over 40 years, told us inflation was “only transitory” is doing his best to foster a post-inflation merry go round.

The Fed’s decision is analogous to the hangover coming the morning after a Friday night binger. This economic hangover, however, will conveniently occur after November’s election, so make sure you start your Christmas shopping early as none of this bodes well for glad tidings.

Typically, The Fed cuts rates in response to economic downspin, not because of a supposed stable and growing economy. Provided the economy goes south with rates already low, this only serves to dig the hole deeper.

The real issue that is ignored, dismissed or unacknowledged is the ever-increasing federal spending. Every dollar spent, pilfers a dollar through taxes, borrowing or money-printing. Unless there are cuts to spending and debt reduction, nothing changes diminishing even further the fading American dream.

How about less government and regulation and more innovation and investment to drive the economy.

The cut is all about the election and The Fed’s preferred outcome. It is nothing short of a lame attempt to prop up the incumbent executive branch that would certainly preserve Powell’s job. No need for the bureaucrats to fret as it is always the working class that takes the brunt of the foibles of incessant government intervention.

The cut also implicitly implies The Fed overplayed its hand and is concerned about a recession.

Prematurely cutting interest rates is the perfect recipe for an increase in inflation. The dollar lost 20% of its value in just three plus years turning greenbacks into proverbial toilet paper.

The Fed’s rate cut in a supposed stable and growing economy only kicks the inflation can farther down the road until after November’s election.

How politically expedient.

Current Events, Recent Posts

Train Wreck in Slow Motion.

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I know some of you are probably tired of my posting these sort of comments as they are somewhat hard to understand and follow without some education in that confusing world of Economics; however, I love it. Read carefully and try to get a grasp of what he is saying and showing you in the charts. Chart #7 is an eye opener of me. As he says, we are about to watch a train wreck in slow motion. I agree with his advice, keeping that money in your bank or under your mattress is not the way to get through this perfect storm we are about to experience. Hard assets will always win out.

Good luck Brothers and Sisters.

Calafia Beach Pundit
Monetary policy is a slow-motion train wreck

Posted: 13 Oct 2021 06:32 PM PDT

There is no shortage of things to worry about. 

That’s a phrase I have used several times over the past decade. I used it as a foil to argue that since the market was quite cautious (and nervous), then a surprise downturn or selloff wasn’t a serious risk. Recessions usually happen when nearly everyone is feeling optimistic. Today there again is no shortage of things to worry about, and the market is within inches of its all-time high. Most disturbing, however, is that neither the Fed nor the administration nor Congress nor the bond market are very worried about inflation. Inflation and all its nasty consequences are, arguably, big things to worry about today.

Fed policy, as laid out in today’s FOMC minutes, is amazingly blasé about the risks of higher inflation. The Fed currently plans to begin “tapering” its purchases of Treasuries and mortgages sometime next month, and to finish tapering by mid-2022. That’s not a tightening of monetary policy; it’s only making policy less accommodative over a prolonged period. Actual tightening—which would consist of draining reserves (i.e., selling bonds) and/or raising the interest rate it pays on reserves (i.e., higher short-term interest rates)—won’t begin until sometime late next year.

The market has apparently agreed that this is a sensible course of action. Inflation expectations embedded in bond prices are somewhat high, but still a relatively tame 2.75% per year (average) over the next 5 years. The bond market is currently pricing in one or two 25 bps “tightenings” by the end of next year (i.e., short-term interest rates of roughly 0.4% to 0.5%), and a 1.5% fed funds rate 3 years from now. By any standard, that would be a supremely gradual pace of monetary tightening. But at a time when inflation is at levels not seen in over 30 years?

This is almost certainly an unsustainable situation. The Fed and the bond market are almost certainly underestimating the risks of higher-than-expected inflation.

How do I know this? It’s all about incentives. Today, the incentives to borrow are huge. Short-term interest rates are below the current level of inflation and will likely remain so for at least the next year. (Even 30-yr fixed rate mortgages are lower than the rate of inflation.) Smart investors and consumers won’t find it hard to arbitrage these variables. In fact, the process is already underway. You simply borrow money and buy anything that is a productive asset and which also has roots in the nominal economy (e.g., commodities, equities, farms, factories, cars). Leverage is your friend and ally in a high-inflation, low-interest-rate world.

How does one place a bet on an asset (in this case the dollar) that is expected to decline in value (because of inflation eroding its purchasing power)? You sell it if you own it, or you sell it short (you borrow it and then sell it). You buy it back when inflation settles back down and/or interest rates rise to a level that is greater than inflation. One way to “short” the dollar is to simply borrow dollars. And a common way to do that is to get a loan from a bank. And when the bank lends you money, the bank can actually create the money it lends you, which in turn expands the money supply. Banks are uniquely able to create money, provided they have sufficient reserves on hand to collateralize their deposits. Since the banking system currently has upwards of $3 trillion in “excess” reserves, thanks to the Fed’s gargantuan purchases of notes and bonds, banks have an almost unlimited ability to increase their lending.

So it’s not surprising that the M2 money supply has expanded at an unprecedented rate over the past 18 months, a time in which the Fed has bought almost $3 trillion of notes and bonds and bank deposits have swelled by some $5 trillion. And it’s also not surprising that in the past six months consumer price inflation has posted a 6-7% annualized rate of growth—a rate last seen in late 1990.

As for Biden, his approval rating is now down to an abysmal 38%. His administration has committed a series of blunders, most notably with the Afghanistan withdrawal. His top priority now is to pass two bills chock full of new social spending and new taxes which he preposterously claims will cost the economy “zero.” Meanwhile, inflation has risen to multi-decade highs, yet both the administration and the Fed keep insisting it’s just transitory. Things will almost certainly get worse if trillions of new taxes and spending, additional layers of bureaucracy, and hundreds of billions of dollars of new handouts and subsidies get lavished on the middle class. My good friend and talented artist Nuni Cademartori sums it up in this cartoon:

As the battle in Congress over Biden’s “Build Back Better” agenda rages, I would urge everyone who thinks this agenda will actually help the economy grow and prosper to read the recently released study by the Texas Public Policy Foundation in collaboration with my good friend, Steve Moore of the Committee to Unleash Prosperity.

The key findings:

• The cost of the Biden Build Back Better plan spread across two bills will reach $6.2 trillion over the next decade.

• The higher tax rates on corporate income, small business income, capital gains, and so on will raise the cost of capital and reduce national investment and the capital stock.

• Compared to baseline growth, the negative impact of these taxes over the next decade will result in 5.3 million fewer jobs, $3.7 trillion less in GDP, $1.2 trillion less in income, and $4.5 trillion in new debt.

While I’m on the subject of Steve Moore, whom I’ve known since the mid-1980s, I will once again recommend you read and subscribe to the Committee to Unleash Prosperity’s free daily newsletter. I read it every day, as do more than 100,000 citizens and Washington policymakers. (One of his recent issues featured Nuni’s cartoon, and another featured some of my recent charts.)

In the study mentioned above you will find details on a plethora of Biden’s tax proposals (e.g., a 12.5% payroll tax on all income over $400K, a reduction in the estate tax exemption of $8 million, and an increase in the top marginal tax rate to 65%) and their likely negative impact on the economy and employment. It’s frightening to think that the people who came up with these proposals apparently believe that the overall impact of BBB will be stimulative. Have they no common sense? Here’s a fundamental supply-side truth: when you tax productive activity and success more, you will get less of it. And when the government borrows trillions only to redistribute the money to favored groups and industries, you get a weaker, less efficient economy. And you also risk boosting already-high inflation.

I’ll wrap things up with some updated charts and commentary:

Chart #1

Nothing illustrates better the supply-chain bottlenecks that currently plague the global economy than Chart #1. Used car prices have literally skyrocketed; in inflation-adjusted terms, used car prices are higher than they have ever been. In nominal terms they are up over 50% since March ’20.

Chart #2

Chart #2 shows how almost half of small businesses in the US report paying higher prices. The last time this occurred was in the 1970s. It’s hard to escape a higher inflation Deja vu conclusion.

Chart #3

 

As Chart #3 shows, bank reserves are very near their all-time high. The vast majority of these reserves are “excess” reserves, meaning they are not required to collateralize bank deposits. Banks thus have enough reserves on hand to collateralize an ungodly increase in deposits via new lending (i.e, money creation). If the Fed doesn’t increase the interest rate it pays on these reserves by enough to make them more attractive, on a risk-adjusted basis, than the interest rate banks can expect to earn on new lending, bank lending will surely continue to expand, and that will fuel a prolonged expansion of the money supply and ever-higher inflation.

Chart #4

 

Chart #4 shows the 6-mo. annualized rate of growth of the CPI (including the ex-energy version). I think this is a fair way to measure what’s happening now, since we are well past all the distortions of last year and the turmoil earlier this year. Inflation by this measure hasn’t been this high since late 1990.

Chart #5

Chart #5 compares the year over year growth in the CPI (I’m being conservative with this) to the level of 5-yr Treasury yields. Yields haven’t been this low relative to inflation since the 1970s. Recall what happened back then: millions of households made a fortune borrowing money at fixed rates and buying houses. Negative real interest rates cannot be sustained for long, mainly because of the incentives they create to borrow and buy.

Chart #6

Chart #6 is an updated version of the one featured in Steve Moore’s newsletter. It’s important to note that the multi-decade trend rate of M2 growth is 6-7% per year. This has been blown away in the past 18 months. If the public tires of holding $3.8 trillion more in bank deposits than they normally would at this time, that’s a tsunami of money that could float higher prices for nearly everything in the next year or so. It’s also worth noting that M2 has been growing at a 10-11% annualized rate so far this year.

What worries me the most right now is how this all sorts out. The Fed seems determined to avoid even the semblance of tightening for the next 12 months. Yet if inflation turns out to not be transitory as they currently expect, how long will it be before policy becomes tight enough to threaten the economy’s health?

Chart #7 

Chart #7 provides some historical context which may help answer that question. Note that every recession on this chart (shaded bars), with the exception of the last, was preceded by 1) a flat or negatively-sloped Treasury yield curve, and 2) a very high real Fed funds rate. Both of those conditions confirm the existence of very tight monetary policy that was intended to keep inflation pressures at bay. Neither condition is in place today, however, which strongly suggests that monetary policy poses no threat to the economy at this time.

Past Fed tightenings, however, were different from what a tightening would look like today. To really tighten policy, the Fed would have to 1) start raising the interest rate it pays on reserves, and 2) start draining reserves by selling bonds. It might take years to get rid of all the excess reserves, however, and no one knows for sure how the economy will respond to higher short-term rates in the presence of abundant reserves—that’s never happened before. In the past, the Fed simply drained reserves until they were in such short supply that the banks were willing to pay ever-higher interest rates in order to acquire enough of them to collateralize their deposits. A scarcity of reserves led to a liquidity shortage, and high real borrowing costs led to bankruptcies and weak investment. Eventually, economic growth ceased, and the inflation cycle was broken.

The dilemma for investors: we might be years away from a return to these conditions, so selling risky assets right now might be premature. And, by the way, holding cash is a guaranteed way to lose money. But how long can you wait, knowing that another economic collapse looms on the horizon?

In the meantime, the prospects for Biden’s Build Back Better lollapaloosa are declining by the day, thankfully, and the spreading disarray in Washington only makes that more likely. I’m willing to bet that if any of his bills survive, it will be in greatly reduced form, and thus much less damaging to the economy. Just letting the economy sort things out on its own would be a great relief to everyone, in my view.

Nobody said investing was easy. There are a lot of things to worry about these days. But I wouldn’t panic just yet. The next year or so might be likened to watching a train wreck in slow motion.

Rik is a great friend and brother Marine with whom I served several times. Thanks Rik, I love this stuff. Give him a call .


 

 

Originally posted 2021-10-17 16:27:42.

Current Events

$1.00 = $0.95

1 Comment

This post may be too hard for some to swallow without some Economics background, but I consider it important enough for my followers to be prepared. I received the following from a trusted Marine brother who runs an investment business in NC. Rik and I are usually on the same page on everything “Economic” because we are both “supply siders” and also “Monetarists.” Won’t get into any Economics BS to explain what that means in layman’s terms as it would only confuse the issue more than it already is. Having said that I totally agree with the article; we are already seeing the start of it. As of this instant, my total portfolio has lost 3.56% in the last month, and I firmly believe it will continue, while inflation is sits and waits for the right time to make itself known to every American. Keep it up Joey  and we will be a bankrupt country while the FED, most of whom are not supply siders fiddle.

 

 

 

 

Your cash will lose at least 5% of its purchasing power in the next year

Posted: 24 Sep 2021 05:03 PM PDT

Earlier this week, Fed Chair Jerome Powell announced that the real yield on dollar cash and cash equivalents is likely to be -5% or less over the next 12 months. Yes, your cash balances will lose at least 5% of their purchasing power over the next year, and that’s virtually guaranteed. So what are you—and others—going to do about it?

Assumptions: This forecast of mine optimistically assumes that 1) the first Fed rate hike of 25 bps comes, as the market now expects, about a year from now, and 2) the rate of inflation slows over the next 12 months to 5% from its year-to-date rate of 5.9%. Personally, I think inflation next year likely will be higher, if only because of the delayed effect of soaring home prices on Owner’s Equivalent Rent (about one-third of the CPI), the recent end of the eviction moratorium on rents, and the continued, unprecedented expansion of the M2 money supply.

I’m a supply-sider, and that means I believe in the power of incentives. Tax something less and you will get more of it. Tax something more and you will get less of it. Erode the value of the dollar at a 5% annual rate and people will almost certainly want to hold fewer dollars than they do today.

I’m also a monetarist, and that means I believe that if the supply of dollars (e.g., M2) increases by more than the demand for dollars, higher inflation will be the result. We’ve already seen this play out over the past year: the M2 money supply has grown by more than 25% (by far an all-time record) and inflation has accelerated from less than 2% to 6-8%. Massive fiscal deficits have played an important role in this, but so has an accommodative Fed. Between the Fed and the banking system, 3 to 4 trillion dollars of extra cash were created over the past 18 months. At first that was necessary to supply the huge demand for cash the followed in the wake of the Covid shutdowns. But now that things are returning to normal, people don’t need or want that much cash. Yet the Fed continues to expand its balance sheet, and they won’t finish “tapering” their purchases of notes and bonds until the middle of next year. That means that there will be trillions of dollars of cash sitting in retail bank accounts (checking, demand deposits and savings accounts) that people will be trying to unload.

If we’re lucky, the inept and feckless Biden administration will be unable to pass its $1.5 trillion infrastructure and $3.5 trillion reconciliation bills in the next several weeks. This will lessen the pressure on the Fed to remain accommodative, but it’s not clear at all whether it will encourage the Fed to reverse course before we have a huge inflation problem on our hands. Non-supply-siders (like Powell) view an additional $5 trillion of deficit-financed spending as an unalloyed stimulus for the economy. Supply-siders view it as a virtually guaranteed way to increase government control over the economy and thereby destroy growth incentives and productivity.

Amidst all this potential gloom, there are some very encouraging signs, believe it or not. Chief among them: household net worth has soared to a new high in nominal, real, and per capita terms. Also, believe it or not, the soaring federal debt has not outpaced the rise in the wealth of the private sector.

Today’s interest rates are relative to inflation. Terribly low! In normal times, a 4-5% inflation rate would call for 5-yr Treasury yields to be at least 4-5%. yet today they are not even 1%. The incentives this creates are pernicious: holding cash and/or Treasuries implies steep losses in terms of purchasing power. That in turn erodes the demand for cash and that fuels more spending and higher inflation.

The growth of the non-currency portion of M2 (currency today is about 10% of M2). Currency in circulation—currently about $2.1 trillion—is not an inflation threat, because no one holds currency that they don’t want. The rest of M2, just over $18 trillion, is held by the public (not institutions) in banks, in the form of checking, savings, and various types of demand deposits. For many, many years M2 has grown at an annual rate of 6-7%. But beginning in March of last year, M2 growth broke all prior growth records. The non-currency portion of M2 is about 25% higher than it would have been had historical trends persisted. That means there is almost $4 trillion of “extra” money in the nation’s banks. This extra money has been created by the same banks that are holding it: banks, it should be noted, are the only ones that can create cash money. The Fed can only create bank reserves, which banks must hold to collateralize their deposits. Today banks hold far more reserves than they need, so that means they have a virtually unlimited ability to create more deposits. And they have been very busy doing this over the past 18 months.

For most of the past year I have been predicting that this huge expansion of the money supply would result in rising inflation, and so far that looks exactly like what has happened. People don’t need to hold so much of their wealth in the form of cash, so they are trying to spend it. But if the Fed and the banks don’t take steps to reduce the amount of cash, then the public’s attempts to get rid of unwanted cash can only result in higher prices, and perhaps some extra spending-related growth. It’s a classic case of too much money chasing too few goods and services. And Fed Chair Powell has just added some incentives for people to try to reduce their cash balances. He’s fanning the flames of inflation at a time when there is plenty of dry fuel lying around.

Now for some good news. The evolution of household balance sheets in the form of four major categories. The one thing that is not soaring is debt, which has increased by a mere 20% since just prior to the 2008-09 Great Recession.

With private sector debt having grown far less than total assets, households’ leverage has declined by 45% from its all-time peak in mid-2008. The public hasn’t had such a healthy balance sheet since the early 1970s (which was about the time that inflation started accelerating). Hmmm….

In inflation-adjusted terms, household net worth is at another all-time high: $142 trillion.

On a per capita and inflation-adjusted basis, the story is the same. We’ve never been richer as a society.

Total federal debt owed to the public is now about $22 trillion, or about the same as annual GDP. It hasn’t been that high since WWII. So it’s amazing that federal debt has not exploded relative to the net worth of the private sector. As I’ve shown in previous posts, the burden of all that debt is historically quite low, thanks to extraordinarily low interest rates.

Gold prices are weak today because the market is anticipating higher short-term interest rates. Gold peaked when forward interest rate expectations were at an all-time low. Why? Because super-low interest rates pose the risk of higher inflation. With the Fed now talking about raising rates (albeit sometime next year, and very slowly thereafter), gold doesn’t make as much sense because forward-looking investors are judging the risk of future inflation to be somewhat less than it was a few years ago.

 

S/F

Rik

Originally posted 2021-09-28 10:45:55.