In case you missed the news this morning: www.reuters.com/article/us-usa-fed-jacksonhole/in-landmark-shift-fed-adopts-average-inflation-target-elevates-jobs-focus-idUSKBN25N0HM
To summarize what happened this morning – “the Fed will seek to achieve inflation that averages 2% over time”. The goal of increasing inflation is to create an environment for job growth and eventually push up interest rates. Let’s dig a bit into what that means.
The Facts (as I can find them online):
- Currently real yields are at 0% or negative
- The US debt is over $26 Trillion, but expected to be over $30 Trillion by 2021
- Inflation is low – currently about 1% for 2020: www.usinflationcalculator.com/inflation/current-inflation-rates/
- The US tax revenue is $3.8 Trillion in FY 2021: www.thebalance.com/current-u-s-federal-government-tax-revenue-3305762
- Here’s where most of it goes (hint social security and medicare/medicaid): www.cbpp.org/research/federal-budget/policy-basics-where-do-our-federal-tax-dollars-go
- US tax interest payments are $393 Billion for 2020
Someone please check this line of thinking, but a 1% increase in interest rates leads to an additional $260 Billion+ interest payment for federal debt. Given we are running a deficit, we can’t afford interest rate hikes given we are printing money to pay off debt, thus raising our debt even more. It’s an infinite loop (think brrrrrrrrrrrr). Thus if we raise inflation higher than our interest rates, we debase our currency (e.g. it’s worth less), and can pay back our debt with money that isn’t as valuable.
Alright, here’s where my Economics Major from a Liberal Arts school is thinking this is all headed. In the short term, Powell wants to increase inflation, which will give Congress the green light for stimulus (Yay! Buy Calls on anything!), and once things are good again (lol), they will begin to curb inflation so it averages 2%.
My question for this group is when has debasing a currency ever been a bullish thing long term and how does Powell ever think the Fed can curb back inflation once the train starts moving?
- Low yields + high inflation have led me to buy GLD/SLV. Buy options expiring in 2021 (SLV under $35, GLD under $220)
- Buy undervalued ETFs like DVY and XLE
- Ignore all news about Covid – Covid news likely won’t cause any more long term market swings with how much money is being injected into the economy
Afterthought: The overnight market has suggested that interest rates should be much higher (www.cnn.com/2019/09/17/business/overnight-lending-rate-spike-ny-fed/index.html#:~:text=Rates%20spike,is%202%25%20to%202.25%25. – hit 10% last September). Synthetically suppressing interest rates is not a good thing. The Fed has been printing into overnight repos since September to keep short term rates low, but if it gets out of hand, you could start to see a jump interest rates alongside increased inflation from the Fed policies. Someone else can try to handle that question – what happens when inflation and interest rates rise…
Disclaimer: This information is only for educational purposes. Do not make any investment decisions based on the information in this article. Do you own due diligence or consult your financial professional before making any investment decision.