Future US Interest Rates, Financial Markets, and the FED
Interest-Rates / US Interest Rates Nov 08, 2018 - 03:06 PM GMTBy: Raymond_Matison
Don’t fight the FED, is a long-established, oft-confirmed market proverb. The FED is indeed an incredibly powerful institution; in fact, it is perhaps the most powerful institution on the planet. It is arguably more powerful than our combined air, sea, and land military forces. These forces can reduce individual military targets to dust, they can flatten cities or even small countries killing thousands of people, but still it is no competition to the FED! The FED with its power over interest rates and money creation, its expansion or contraction, its Petrodollar and global trading currency, its open market operations, and its foreign currency exchange markets can destroy the value of foreign currencies, and start revolutions. It can injure or even destroy economies of single countries or even whole regions of the developing world, in turn crippling the lives of tens or even hundreds millions of people. It can finance wars, determining who will be victorious.
Reflect first on the last ten year period - after the near global meltdown of our financial markets in 2008. The direct and determined intervention of the FED reducing interest rates to historical lows for nearly a decade and creation of trillions of new dollars caused the stock market to rise fourfold from its nadir in 2008 to its high in 2018. By creating trillions of new dollars, it saved the global banking system from collapse. With its influence over foreign exchange markets, it has maintained U.S. dollar hegemony even as it crashed currencies and economies of countries it sees as strong competitors or unacceptable owners of vast natural resources which our elite globalists want to control, weaken or punish. That is the power of the FED.
Historical FED prowess
Economic history shows that the US was able to participate in WWI because the then recently formed FED created dollars by which we could financially “afford” to participate in that wholly European war. In his book “End the FED” author Ron Paul states “the United States might have stayed out of the conflict. But having the Fed, the United States entered the conflict in 1917. There were … new bonds to float, and a massive expansion of government debt that was backed by the power of the Fed to create money to pay back the debt.” After WWI the FED’s further expansion of money promoted low interest rates which created the stock market of the Roaring Twenties. Its decision to raise interest rates in the late 1920s caused the Great Depression. The FED also had the power to sideline real gold-backed money, drive gold out of public circulation in the 1930s, and replace it with a system it could more readily manage or manipulate.
The FED also facilitated “paying” for our participation in WWII, by distributing record volumes of Treasury bond issues through its banking system, thereby allocating war cost to every citizen. As England and other countries purchased war materials from the United States with payment in gold, it accumulated the greatest hoard of gold ever amassed in the history of the world. It then created a new global monetary system based on the dollar which was to be “as good as gold”. But a scant twenty five years later it was obvious to most countries that the dollar was not as good as gold, and the United States had to close their gold exchange window in 1971 to protect its diminishing gold stock from being lost to foreign countries seeking to exchange their dollars for gold.
That decision, which was a currency default for America, stole billions from foreign countries accumulating dollars. Gold rose from $35 an ounce to $1230 at present, while the paper dollar’s purchasing value has dropped to just sixteen cents. The then Secretary of the Treasury Mike Connolly brashly pronounced that “the dollar is our currency, but it’s your problem”. With the strongest military power in the world backing the FED, it easily prevailed and convinced a still recovering Europe and the rest of the world to use the “new” gold un-backed dollar as there were no alternatives.
What followed in the 1970s was a period of massive new money printing and credit expansion, which caused a decade of accelerating inflation, market decline, and economic retrenchment. A new FED chairman, Paul Volcker, was appointed to stem ravaging inflation, with the result that in 1981 interest rates rose to their highest rate in the century. The FED’s subsequent resolute action caused interest rates to decline for the next three decades.
Despite the closing of the gold exchange window in 1971, and purchasing power of a dollar declining to just $0.16 today - countries still buy and hold vast amounts of U.S. Treasury debt, and the dollar is still the global trade currency. Both China and Japan hold over $1 trillion of Treasury securities, as the global banking system holds approximately $7 trillion in their bank reserve accounts. This speaks volumes about the real power of the FED.
Over decades its policies have changed the very structure of the American family, its workforce, its attitude towards savings, and caused a debt enslavement of its citizens. In effect its power has been so limitless that it has changed the very culture of this nation. (See: America’s One-sided Domestic Financial War,
http://www.marketoracle.co.uk/Article62465.html
Interest rates
FRED (Federal Reserve Economic Data) available on the internet shows changes in historical interest rates. Here we summarize historical sweeping movements of longer term interest rates in the following brief table.
Time period Number of Years Overall movement
1869 - 1900 31 8.1% - 3.7%
1900 - 1920 20 3.7% - 7.2%
1920 - 1946 26 7.2% - 2.1%
1946 - 1981 35 2.1% -14.1%
1981 - 2012 31 14.1% - 2.1%
2012 - ? ? 2.1% - ?
Interest rates since 2012 have remained historically low, one might say essentially flat, following FED Chairman Bernanke’s announcement that interest rates would remain unchanged until the rate of inflation had risen to 2%, and unemployment had declined to 4% before the FED would raise interest rates. Since interest rates have started to rise, we should assume that these targets, as the FED views them, were achieved.
Inflation is by definition the increase in our money supply. Price increase is the result of increasing money supply. We have experienced significant price increases in housing, and the stock market. Anyone trying to purchase today a portfolio of stocks for their pension or annuity account will now have to pay four times the amount of that paid ten years ago. This asset inflation has increased income inequality and diminished the middle class – the bedrock of our democracy.
What this preceding table demonstrates is that movement in interest rates once started in a specific direction, usually continues for a significant period of years. Note that in the 1920-1946 year period the overall long term move of interest rates was down, but they did rise enough in the late 1920s to cause the stock market rout, which led to the Great Depression. After the recent decline of interest rates to historical lows, the FED is now on a course to raising them. While it is likely that in the rise of interest rates over the next decade, there will be short term interruptions or even short term reversals, but the rise of interest rates is likely to persist over a long period, similar to those in the past. The following chart shows the FED’s historic interest rate high, its decline over the next thirty years, the persistent near zero rates of the last decade, and finally its beginning rise in the last two year period.
If history is any guide to future events, we could project that the FED will continue to raise interest rates, significantly over a many year period. The implications of such a continued rise in interest rates are momentous – as it is capable and likely to destroy our stock and bond markets, citizen pension and retirement systems, take down our financial system, and thereby destroy our fiat currency.
Implications of rising interest rates for the stock market
From historical data we know also that direction of the broad stock market usually maintains its momentum and direction for relatively long periods of time. For example looking at the following table we can see that when the market started to rise from a previous low point, or decline from a previous high point, it did so over a period of many years. Such advances and declines are summarized for the Dow Jones Industrial Average in the following table.
Time period Number of Years Overall movement
1921 - 1929 8 936 - 5,011
1929 - 1932 3 5,011 - 1,019
1932 - 1966 34 1,019 - 7,807
1966 - 1982 16 7,807 - 2,093
1982 - 2018 36 2,093 - 26,828
2018 - ? ? 26,828 - ?
In printing the last time period for a market rise as 1982-2018, we have made the reasonable presumption that 2018 is the end of the previous period’s rise. Note that in 1987 there was a huge market collapse called Black Monday, but as market liquidity was supported by the FED, the momentous decline was soon negated as markets powered ahead into record territory.
Markets have been manipulated by a multi-decade reduction of interest rates, and massive quantitative easing accumulating to multiple trillions of dollars over the last decade. Now, as interest rates have reversed and are deemed to rise further, the US dollar is strengthening, and looking more attractive from a foreign investment point of view because both of the rising yield rate, and as an apparent refuge relative to other country weakened currencies. However, this U.S. dollar strength makes it more difficult for foreign borrowers to both service and repay their debt in dollars. If interest rates continue to rise, and the dollar continues to gain strength, it may depress foreign currencies to the point that their banks will need to sell their dollar reserves in order to buy their own currency as a means to improve its market price. Such sales would unfortunately raise bond yields and further strengthen the dollar, reinforcing this unwelcome cycle.
Raising bond yields will shift money from the stock market into the bond market, weakening our equities market. Higher interest rate costs will also likely reduce financing corporate buyback of stock, and increase corporate costs, negatively affecting profit margins and stock prices. Higher interest rates also raise the cost for investors who buy stock on margin, raising the risk of bursting our market bubble and accelerating a decline. Adding to this, the withdrawal of $50 billion per month from the money supply by the FED reduces liquidity, raises interest rates, and depresses borrower economies. Finally, a strong dollar is not supportive of U.S. exports, and therefore undesirable to our economic policy.
FED’s Chairman Powell says that the economy is strong and that he will raise rates above the neutral rate. Therefore, he will keep hiking rates at least over the near term.
Many have criticized FED decisions in the past as being too much, too little, too late, etc. Even President Trump has complained that former President Obama had the benefit of zero rates of interest. But Ron Paul, a long time critic of the FED, states in his book “End the FED” that “When the printing presses are available to the government and the banking cartel, they will use them rather than to do the right thing. The problem isn’t with the choices made by central bankers. The problem is that they possess the power to make any choice at all.”
Insufficiency of fundamentals
For over more than ten years some market observers have noted that many economic fundamentals had been declining. Such contention is not only corroborated by the dramatic market declines of 2000 and 2008 which act as leading indicators, but also by our burgeoning national debt, and the need for continuing interest rate suppression and money expansion - accommodation by the FED. Both of these observations are indicative of its continuing policy of crisis management. Accordingly many astute pundits for years on end predicted that our financial markets would “soon” decline - yet the markets would not decline.
More accurately, the timing of coming market declines was not correct, while the increasing mountain of supporting financial statistics kept suggesting that a both an economic, market crisis, and financial system has to soon surface. Why was the timing by these observers wrong? Simply stated, it was because the FED (until recently) maintained an accommodative policy towards money expansion, interest rates, and markets. All other reasons expressed through media should be considered as just diversion or “signal noise”.
Recently President Trump criticized Chairman Powell of the FED for raising its primary interest rate by 25 basis points at their last meeting. That sort of a rise is not much; however, if the FED persisted in raising interest rates every three months at that small 25 basis point rate, over two years interest rates would rise by two percent from present levels. Accordingly, we could project that the Treasury interest rate for 10 Year Treasury bonds would rise to 5%. That would become a significant rate which would negatively affect government’s fiscal budget and governments financing needs.
For example, with our national debt at nearly $22 trillion, and growing rapidly, soon the annual interest cost on this debt would rise towards $1 trillion (compared to $ 371 billion presently) as lower interest rate debt matures and is reissued at the higher rates. This level of interest cost would spur further budget deficits and increased borrowing, which in turn would increase interest rates and debt service costs. It would become a highly un-virtuous and deeply damaging cycle that would cause financial markets to decline.
Now that the current FED Chairman Powell has notified the public that it will increase interest rates, conduct operations that pull liquidity out of the markets – they have started what will become a multi-year decline in financial markets. Thus, it is reasonable to expect that even if economic statistics show some improvement – this will not suffice to maintain or improve market multiple or investment returns. Our bond and equity markets are now being managed to head down for multiple years. So, do not fight the FED, for you will lose.
FED’s QE and QT
Normally, reduced interest rates coax consumers to borrow money for either consumption or investment. The consumer was already overly indebted, and could no longer support the expansion of a consumer driven economy. In addition, the huge destruction of capital from mortgage bond defaults and its asset backed loans a decade ago meant that banks themselves needed capital to prevent their failure. The FED created trillions of dollars to save domestic and foreign banks alike. Electronic and paper printing of this fiat currency was also done to provide confidence to the populace that banks were well recapitalized and “safe”.
The FED purchased bank problem loans at face value, rather than pay what the market price was for defaulting debt. Is it not amazing how easy it was for the FED to make the banks “safe”? (Are banks really safe - since new legislation makes our deposits junior liabilities of banks, which in the case of a bank failure, deposits would unlikely be repaid to its account holders?) With some market nudging, forward guidance in the form of keeping interest rates low, and the stock market not only took off, but kept rising like a balloon. The FED showed its true power when markets kept rising even when high-profile long-time money managers called the market overvalued. Even when Former FED Chairman Greenspan pronounced the market to be in bubble territory, the market continued to rise.
Finally, the FED’s Board of Governors decided that its own balance sheet was too bloated, having risen from approximately $.5 trillion to $4.5 trillion - so for the purpose of being prepared to help prime the next economic recovery it implemented QT, or quantitative tightening. It meant that it would allow bonds to mature, but the FED would not reinvest proceeds in new bond offerings. It also meant that the FED sold some of its portfolio bonds, which took money out of the system, decreasing liquidity and increasing market volatility. Pretty soon its effects were seen in the stock market with notable weakness at the beginning of 2018 and again just recently. Media spokesmen may argue that trade tariffs, developing country debt default, domestic budget issues, EU discord, Middle East instability, or other compelling reasons are responsible for this market volatility and weakness. But the ultimate answer is much more simple than that – it is due to the actions of the FED. Do not fight the FED!
EU and other global issues
The European Union as it is now structured, configured and directed is failing. There are many examples of why it is vulnerable and failing: recognized looting of Greece raises fear in other EU members; the decision by Britain to exit the EU; resistance to EU bullying over Italy’s budget, and their sovereign bond risk; the increasing resistance of Hungary, Czechoslovakia, and Poland to EU dictates; the fatal weakening or failure of many old world banks including Deutsche Bank - previously the strongest bank in Europe; the ECB bank operating beyond its legally authorized constraints; the migration mess stemming from EU leadership forcing acceptance of foreign mostly male uncivilized mobs onto sovereign countries who seek to maintain their unique and respectable old cultures; the successful rise of political parties in recent elections who are opposed to current EU policies; Spain and Catalonia’s struggle to become an independent country. Their interconnectedness means that each of these problems will weaken the cohesiveness of the European Union. In addition, their economic connectedness with America and the rest of the world means that any and all of these problems can and will affect our economy and financial markets.
EU member countries have been seeking its right to act as sovereign nations rather than U.S. vassals. They seek trade with Turkey, Iran, and Russia. Germany and some other countries do not fear a European invasion by Russia, instead they seek to solidify a mutually attractive trade relationship with these countries. It is America which needs countries as “enemies” to keep the military-industrial complex expanding. Europe is now ready to create its own international electronic money transfer system, as Russia and China have already done in order to circumvent America’s seizing control of the “independent” SWIFT money transfer system to implement sanctions on other nations at will. Their willingness to act independently reduces America’s global influence.
China, Russia, India, South America, Iran, and South Africa, (the CRISIS nations. See BRICS? No, CRISIS: http://www.marketoracle.co.uk/Article53009) are all working or participating in the alternative or mirror image financial institutions of America to escape its dollar hegemony and elude its sanctions. It is an effort by previously injured countries of the world to escape financial colonialization practiced by globalists. This process is realigning also the fealty of nations in the Middle East, with negative implications for the Petrodollar and value of our own domestic currency. Progress in building the Chinese Belt and Road Initiative will provide participating countries with durable growth from which America and its dollar will largely be excluded. This will require America to find more innovative ways to maintain its growth, but it raises last-century industrial production growth opportunities for countries that are economically less developed, which our leaders often define as “enemies”. These long-term trends will also ultimately be reflected in our economy and financial markets.
When united together, small and militarily weak countries eventually will pose a staunch resistance against strident U.S. globalist policies who may soon no longer back down to our financial sanctions or military threats. The oft-mentioned military grouping of China, Russia and Iran together could possibly nullify the military might of America. We all know and understand that America cannot invade China, Russia, and Iran or hold invaded territory, as it has been unable to do that with the far weaker countries of Iraq or Afghanistan. Reciprocally, China, Russia, and Iran’s combined efforts could not invade or hold America. But continued provocations raises the prospects for intentional or accidental nuclear war.
Conclusions
Everyone has an opinion on the market. There are many who believe that the market is vulnerable because they expect the economy to slow down, while there are others who believe that the current pullback is just a small correction before that market resumes to go higher. There are also those who believe that the global fiat money system has been misused and is broken; accordingly, this system is not sustainable, and it will crash in the future - to be replaced by a more honest monetary system.
When markets over the last five years kept rising into bubble territory many financial advisors were alerting stock owners that the market is likely to decline or collapse. From a fundamental financial analysis viewpoint that made and continues to make perfect sense. Many conservatively oriented investors (including this author) kept alerting investors of the coming market demise, even as markets continue to rise. This author simply advised investors to be on the sidelines with cash at the ready, for Mr. Rothschild’s buying signal to “buy when there is blood in the streets”. It turned out that it was not sufficient for the market to be high and the economic fundamentals poor – to bring that market down; it required the active redirection of activity by the FED to change direction of the market. The FED has taken this action, so this is not the time to buy – it is the time to sell. Our equities market could readily decline by more than 50% over the next five year period, so if you are to play in this market – go short. The time to purchase stocks may still be five years away. The only caveat for this outlook is the possible rapid rise in price inflation which would drastically decrease the purchasing value of our dollar, commensurately increasing the price of everything else – including our stock market. We will all see how this evolves.
It is clear from the emphasis of this article that interest rates are now rising, and are likely to rise for a long number of years. This rising interest rate will raise the cost of production and negatively affect profit margins. The higher interest rates may also pop some interest rate derivatives adding fireworks to the stock bubble deflation, which will decline also due to equity risk money moving to the “safety” of the bond market. However the bond market this time will also disappoint because rising interest rates generate lower long term bond values. In addition, corporations now have more leveraged lower-quality debt capital structures. Thus stocks and bonds are exposed to decline over a long period of years. The resulting reduction in financial wealth will slow the economy and drag it at least into a deep and long recession. Such economic conditions are further acerbated by financial, economic, and structural problems in the EU, and slowdown in China’s production and financial leverage.
The CRISIS countries will attempt, over the long term, to promote their competing currencies (perhaps with gold backing) to that of the dollar. This currency competition, and U.S. increasing budget deficits resulting in growing national debt financing reduces confidence in the global dollar reserve currency. This leads ultimately to a loss of confidence in the FED, whereby its franchise becomes limited by a nation of angry bankrupted citizens marching on Washington and its corrupt politicians. The world increasingly is exposed to uncivil turmoil, leading to more global chaos, and the rising threat of war.
A new astrophysicist study just completed estimates the number of galaxies extant in the universe. That current estimate is two trillion galaxies! This huge number of galaxies in the universe should end the debate about life existing elsewhere in the universe. We can safely assume that there are millions if not billions of habitable planets among the two trillion galaxies. With this acknowledgment there are three interesting questions that come to mind. Since the universe is calculated to be about 15 billion years old, but the earth only four billions year old it is clear that there are galaxies, planets, and life forms which may be one hundred, one thousand, one million, or even one billion years older or more advanced than life on earth. Considering the dramatic advance in science in the last one hundred years here on earth, it would be tempting to imagine what life on earth would be like in another one hundred years. A more difficult question would be to understand what life on distant galaxies is like for those which are a million years more advanced.
Finally, the most challenging question would be to understand as to on how many life-bearing planets these advanced life forms would have been extinguished by their own action - war. It takes civilization and advancement to destroy a whole planet – cavemen cannot do it. If global conditions become austere enough, increasing turmoil and chaos, it should not be surprising for us to be witness to a horrible war – as this has proven to be the most utilized historical solution to harsh economic problems. In trying to solve our global economic problems of competition for limited resources with unlimited fiat currency systems and arrogant military hubris, can the earth life-form leaders be wise enough to avert the calamity that has likely befallen life in other galaxies?
Raymond Matison
Mr. Matison was an Institutional Investor magazine top ten financial analyst of the insurance industry, founded Kidder Peabody’s investment banking activities in the insurance industry, and was a Director, Investment Banking in Merrill Lynch Capital Markets. He can be e-mailed at rmatison@msn.com
Copyright © 2018 Raymond Matison - All Rights Reserved
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