The fed has fucked up. Inflation wasn’t transitory and their favorite measure, core PCE, is the highest it’s been in 4 decades.
Now they have to look like they are fighting inflation by raising rates and tapering asset purchases. They are talking quite a big game right now. Many fed officials are talking about a fed funds rate at 3-4% and several are even mentioning balance sheet runoff.
I’m here to tell you they are completely full of shit. We won’t even get close to 4% fed funds rate this cycle. And that’s because as a nation we are increasingly dependent on low interest rates to finance the national debt (as well as private debt).
That’s because the national debt has absolutely exploded over time. Debt to GDP has increased from 30% in the 70s to 125% now.
This massive increase in the debt means that interest payments on that debt increase as the fed raises interest rates. Thus every hiking cycle for the past 40 years has resulted in a lower and lower peak fed funds rate before the market breaks and the fed capitulates and begins easing again (aka the money printer kicks into high gear). The last peak in 2018 was a fed funds rate of 2.25-2.50% before markets plunged 25% in the 4th quarter.
But the debt is even higher now than it was in 2018, so we know the next ceiling will have to be lower as well. I’ve analyzed this by looking at the average of the fed funds rate and the 5-year treasury yield and multiplying this combined rate by the national debt.
If we assume both rates increase in tandem by 25 basis points per quarter, and the national debt goes up a paltry $300 billion quarterly (its been going up much faster than this recently), then we will cap out at just 1.25-1.50% this cycle. Likely in the 2nd quarter of 2023.
So when markets are crashing after only the 5th rate hike, and inflation is still running at over 5% annually, just know that the fed is going to capitulate and save the markets by easing again.
This is a big problem, because you need treasury yields to get above inflation expectations in order to encourage savings instead of spending to stop inflation. In the 70s, with debt to GDP at only 30%, we were able to do just that. It wasn’t painless (look at the recession of the early 80s), but we did it. With inflation at 5-10%, we can’t even get close to stopping it without absolutely decimating the stock market and the economy.
So the fed is trapped. They are going to have to choose between switching to easing and saving the economy and stock market, or continuing to hike in an attempt to kill inflation, but also causing the great depression 2.0 in the process. I’m confident they will choose to save markets and stop fighting inflation as the tradeoff, which means that the inflation trades at that point will be going absolutely bananas.
And that’s because the US will finally be embarking on monetary policy akin to a banana republic by lowering rates while experiencing high inflation.
So make sure you get YOUR bananas over the next year to prepare for this utter bullshit of a ride that the fed is about to take us on. For me that means precious metals (specifically silver via PSLV and physical, not SLV which is a bullshit ETF). I also like platinum and uranium a lot as well. For others it could mean other commodities, energy plays, or real estate. Or even just buying a whole bunch of shit before it goes up in price.
Good luck my friends, this is the end game!