With a Fed rate cut extremely likely this month, Jim Puplava and Chris Preitauer discuss on Financial Sense Newshour the economic impacts and what to expect as the global economy continues to cool.
More Rate Cuts Likely
The Fed all but confirmed at least a quarter point cut coming this month, and with a half-point cut increasingly likely, the futures market is speculating three more cuts this year. This will probably take the federal funds rate below two percent. This is a complete reversal from the Fed, which was talking about raising rates earlier this year.
Failing rates aren’t unique to the U.S. We are entering a global easing cycle that began this year, Puplava stated, with the Bank of Korea, Indonesia and South Africa all lowering rates this week. Aside from the Fed, the ECB is next on deck for cuts, Puplava added. We could see rates as low as 1.75 percent in the U.S. by the end of the year.
New York Fed Governor John Williams drove up expectations for a half-point cut with his recent comments stating swift action is needed and that the Fed should not try to hold back.
“Those comments ignited a rally in both short- and long-term Treasuries,” Puplava said. “It’s reinforcing the idea that a half-point versus a quarter point is much more likely at the end of the month. It turned the markets around from negative territory this week into positive territory.”
Global Economy Teetering
Global growth is slowing down substantially and government deficits around the world are ballooning, Puplava stated. The U.S. deficit currently nearing $22.6 trillion and is on its way higher.
Tremendous amounts of debt overhang world markets at all levels, from government and corporate debt to consumer debt. Three quarters of U.S. corporate bond debt is low-rated and as much as 50 percent is BBB, Puplava noted. A quarter of corporate bond debt is junk-rated.
If the U.S. enters a recession, credit spreads will blow out. Companies will not be able to roll over debt, Puplava said, which leads to defaults that can quickly turn into a financial crisis. The Fed is trying to get ahead of this possibility, he added, as it is often criticized for acting too late after raising interest rates too high, effectively triggering the next recession. Interest rates have never been this low for this long in recorded history. Around one-third of European has a negative yield, and Japanese debt is also negative.
“More unconventional monetary policy is forthcoming,” Puplava said. “We’ll most likely see helicopter drops in Europe. Some economists, such as Gary Shilling and Kyle Bass, think the yield on 10-year Treasuries will drop below one percent to .75% … That is why you had Fed Governor Williams say, ‘Let’s not beat around the bush. Move quickly and fire all of your bullets rather than wait and hesitate.’”
With the U.S. outperforming major developed economies, the dollar continues to gain against other currencies. U.S. interest rates are relatively higher than many major economies. In the event of further slowing, the U.S. becomes a safe haven with more capital flowing in, thus further exacerbating the problem.
As a result, it is going to be difficult for the U.S. to weaken the dollar effectively. As no country wants to see their currency gain value against the dollar, the Fed and Treasury will likely have to go it alone. This is essentially how currency wars begin, Puplava noted.
“The problem is that it becomes a zero sum game,” he said. “When you’re taking steps to weaken the dollar and your trading partners are doing the same (to weaken their own currencies), it just doesn’t work.”
Shelter from the Storm
Gold and silver have both benefited from the news of impending rate cuts. This has the potential to further inflate asset values around the world. Puplava added we could be headed for a collision between fiscal and monetary policy.
Investors should consider moving into conservative investments as well as risk-on investments, Puplava said. Defensive sectors within the S&P such as consumer staples, REITs and utilities look attractive. It is also necessary to hedge against the possibility of currency wars breaking out. A position in precious metals would be appropriate, Puplava noted, as well as a move away from assets that are likely to see dividends fall to zero with interest rates.
“If you’re dependent on your investments for income, you need to take steps now to preserve or establish an income floor,” Puplava said. “The best yields around can be found in the stock market, where you can get yields ranging from three to six percent. But you need to think about this now because yields are global and they’re heading lower, including in the U.S. We are now zero bound.”