Fed Cuts Rates But Bond Rates Are RISING

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FED CUTS RATES, BUT…

Just a couple of weeks ago, on September 18th, the Fed announced a 50 basis points cut in interest rates. To be clear, the announced cut was generally expected and already discounted in the markets. Most markets had risen substantially over the prior two years in anticipation of a change in direction for interest rates, which had risen sharply and then had remained at higher levels until the recent announcement.

Most investors and analysts appeared to be waiting for the Fed to confirm what was already “known and expected”. Reaction to the official announcement was mostly positive as stock prices continued their upward march and mortgage rates declined.

Bond prices, however, peaked at about the same time the Fed made official its latest gratuitous action. Over the past three days, bond prices have dropped sharply, gapping down at the market open each day. Below is a chart of TLT (20+ Year Treasury Bond ETF)…

Since the Fed announcement, TLT has dropped from a 52-week peak of 101.64 to 95.55 at today’s close. That is a drop of 6% in bond prices at a time when other markets are shouting approval of Fed action and extending recent gains. Why are bond rates rising at the very time the Fed is trying to move interest rates lower?

INFLATION? RECESSION?

A singular possibility is that the bond market sees something other markets don’t; at least, not yet. What is likely troubling to the bond market at this time is the threat of a resurgence of inflation; more correctly, the effects of inflation.  Cheaper money and credit now, in the short term, could have serious negative consequences later on. Bigger increases in the CPI and PPI will get everyone’s attention.

A peculiar contradiction to the rise in bond rates is the fact that mortgage rates have declined. In other words, mortgage rates are reflecting what might be expected to happen as a result of the Fed’s efforts to engineer rates lower for now. But, that does not explain why bond rates would move opposite to the Fed’s action and intent.

Finally, the bond market may be ahead of the curve with respect to what comes next. Stock investors seem almost oblivious to the reality of accelerating deterioration in the economy. Stock prices will eventually reflect that reality. (see If The Markets Turn Quickly, How Bad Can Things Get)

Also, the bond market might be telling us that rates need to move higher, and remain at a higher level that is more consistent with historical averages. This could happen in spite of the Fed’s efforts to lower rates, regardless of intention and desire. (also see What Happens After A Rate Cut Is Announced?)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

If The Markets Turn Quickly, How Bad Can Things Get?

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HOW BAD CAN THINGS GET? 

Pretty damn bad. Which means that it will likely be much worse than most of us can imagine. Other than Covid and its forced shutdown of economic activity by governments world-wide, the most recent learning experience for investors is the Great Recession of 2007-09. Beginning in October 2007 and ending in February 2009, the S&P 500 Index lost 53%…

 S&P 500 Index 2007-09

 

Most of that loss (38%) occurred during calendar year 2008. It was the largest single, calendar-year decline since a similar -38% in 1937. Both the NASDAQ (-53%) and DJIA (-50%) declined by similar amounts.

Prior to the Great Recession, post-Y2K markets collapsed in a heap on the heels of the most profitable decade in U.S. financial and economic history. For more than 2 1/2 years, between February 2000 and September 2002, stocks were in a tailspin led by the NASDAQ which declined by 80%. The carnage is pictured on the chart below…

NASDAQ Composite 2000-02

 

The extent and breadth of the declines and accompanying bankruptcies of hundreds of dot.com companies is rivaled only by the Stock Market Crash of 1929 which is shown on the chart (source) below…

Dow Jones – 1929 Crash and Bear Market

Over an excruciating three years (September 1929 – July 1932), stocks declined by 90%. Stocks did not recover their original pre-crash levels until 1954, twenty-five years after the September 1929 peak. The accompanying economic depression lasted until 1941, although a significant portion of what is termed a resumption of economic activity, was accounted for by war-related industrial activity. Economic conditions on the homefront were characterized by rationing, price controls, and shortages.

WHAT MIGHT CAUSE A MARKET CRASH? 

Stock market crashes like those described above don’t happen spontaneously. There are a number of factors which lead to eventual corrections of significance. They include the evolution of normal business and economic cycles, duration and extent of previous stages of those cycles, intervention and manipulation by governments and central banks, the need for corrections and rebalancing due to poor judgement and market excesses, and political and economic factors.

U.S. economic activity has been declining broadly for more than a year or two. That is partially attributable to changes in interest rates which have caused a reassessment of cost factors and undermined the credibility of various investment strategies. The manipulative expansion of cheap and easy credit over the previous four decades resulted in excesses that weren’t fundamentally justified and which distorted the financial landscape. Highly disproportionate availability of cheap credit led to serious misallocation of resources and capital. 

In addition, the use of leverage has exacerbated the problem. The unfathomable and unexplainable derivatives monster has the potential to wreak incalculable damage on the financial markets. The use of leverage throughout all markets – stocks, bonds, commodities – and including the use of options, futures, and other more precarious derivatives, currently rivals its pre-1929 use which approached 90%.

The  currently added recent market excesses are based on expectations for a return to cheap credit. It is assumed that once the Fed announces a rate cut, that a return to the good old days is right around the corner. As much as a 50 basis point cut is already factored in to current stock and bond prices. What happens when that cut is announced? (see What Happens After A Rate Cut Is Announced?)

MORE ABOUT THE FED

The Fed will likely NOT pursue a series of significant rate cuts UNLESS there is an acceleration of the current decline in economic activity. It makes no sense to simply return to the hell that was brought about by its own intentions and actions previously, and which forced them to try to navigate a return to a more normal and reasonable, higher level for interest rates. On the other hand…

Since the Fed is occupied mostly with slaying dragons which it birthed by its own errant monetary policy, including more than a century of intentional inflation, they are doomed to a life of putting out fires and containing collateral damage. For investors, it is time to wake up to the fact that the Fed is not your financial savior and its purpose and goals, irrespective of any so-called mandates, are not aligned with yours.

CONCLUSION

It is possible that a deepening recession (official or not) could morph into something worse – an economic depression. Even if the Fed cuts rates aggressively, it might not be enough t0 stop the cascading waterfall of lower prices for all assets priced in dollars; including stocks, bonds, commodities, real estate, etc. A collapse in the credit markets such as that which occurred in 2007-08 would likely overwhelm any efforts by the Fed to stop the hemorrhaging.

It would not be unreasonable to see prices decline by  50% or more initially. Further declines would be likely as it is unlikely that an event of this nature at this particular time could be reversed in timely fashion. The prevailing conditions of unemployment and shuttered doors spawned by wholesale financial destruction would be too much for a beleaguered Fed.

It may or may not happen, but investors who ignore the possibility could be in for a shock. I do not consider the likelihood of such an event, or the reaction of the Fed or the government, to be altered in any significant way regardless of November election results. (also see: Default – Deflation – Depression)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

Siren Song Of Gold Mining Shares

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GOLD WILL CONTINUE TO OUTPERFORM MINING SHARES

No amount of wishful thinking and baseless proclamations will change that. Owning gold stocks (miners) instead of the actual physical metal (in other words, processed and refined with appropriate hallmarks and in tradable form) is a losing bet. Investors should ignore the siren song of gold mining shares.

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Silver’s 50-Year Bear Market

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Recent articles trumpeting silver’s outperformance relative to gold and some ridiculous price projections are a bit too much. Missing from most of the extremely positive commentary is a dose of reality. Below are three charts (source) which should provide some needed perspective. The charts show average monthly closing prices (inflation-adjusted) for the periods August 2020 – July 2024; April 2011 – July 2024; and January 1980 – July 2024. Here is the first chart…

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Bonds, Stocks, Gold, & Silver – Volatility On Display

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The bond market seems convinced that interest rates are headed lower for now.   The chart (source) below shows the price action for TLT (iShares Long-term Treasury Bond ETF) over the past seven days…

Of particular note is the fact that the succession of higher opening prices left a series of gaps on the chart. Friday’s gap is the largest so far. Also, the total increase in price from Thursday’s close amounted to more than 3%, and accounts for one-third of the entire seven-day advance.

OTHER MARKETS

Other markets did not fare so well; particularly stocks, which sold off in aggressive fashion on Thursday and Friday.  The NASDAQ Composite Index lost 6.7%, while the S&P 500 and DJIA were both down about 4 1/2%.  This stands in stark contrast to the sharp increase in Treasury bonds. See charts for all three stock indexes below…

 

 

INCREASE IN VOLATILITY 

Oxford Languages defines volatility as “liability to change rapidly and unpredictably, especially for the worse.” People tend to focus more on “especially for the worse” when referencing volatility; however, the past two trading days in all markets have highlighted that “rapidly and unpredictably” might be more descriptive and accurate.

In addition to the volatility evidenced in both stocks and bonds, there was a better example on display in the metals markets. In early morning trade spot gold was priced as high as $2478 oz., $32 higher than where it closed the day before. Then, in the space of one hour, the gold price dropped $70 oz. to $2408. Over the course of trading gold rebounded and closed at $2443, down a negligible $3 oz.

Silver’s price action was even more rapid and unpredictable. After rising to a daily high of $29.30 oz, which was up $.84 over its previous close, the white metal dropped nearly 5% ($1.40 oz) during the space of one hour. The daily low was $27.90. Afterwards, the price rebounded to close just a few cents above its prior day’s closing price.

Here are charts for both GLD (SPDR Gold Shares ETF) and SLV (iShares Silver Trust ETF) for the same time period shown in bonds and stocks above…

 

CONCLUSION 

As we said last week: “Rate cut or not, what happens after will not be as expected or intended.” There has been no announcement yet, but the bond market is acting as if it is a done deal. It is possible that stocks are selling off under a similar presumption. Here is why…

Most investors drove stock prices higher in anticipation of rate cuts in the near term, expecting that lower rates would trigger additional economic growth and lead to capital expansion and higher stock prices. Unfortunately, the effects of a potential rate cut are already accounted for in current stock prices. The highly anticipated announcement isn’t likely to have much positive impact on stock prices and could actually trigger more selling. Also, the rapidly weakening economy could override any possible stimulus from the cut(s).

Meanwhile, volatility, i.e., the liability to change rapidly and unpredictably, especially for the worse, can be expected to increase in all markets.

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

What Happens After A Rate Cut Is Announced?

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WHAT HAPPENS AFTER A RATE CUT?

Has anybody considered what might happen after a rate cut is announced? If the Fed signals a change in direction regarding interest rate policy, as expected by most observers at this point, does that also signal an end to increasing weakness in the economy? Will a recession be averted (officially or not, we are in one) and employers start hiring again? Will people be able to find full-time jobs at satisfactory pay rates; will housing become affordable?

The expectations are there for a cut before the end of the year, probably by September. It is possible that what happens after that might not be consistent with current expectations. In other words, there is a level of deterioration in the economy (liquidity problems, bankruptcies, empty spaces for lease or sale, etc.) that doesn’t suddenly reverse and restore itself.

Most investors and others are so fixated on the potential rate cut that they likely haven’t given much thought to what comes next. That is, assuming that a rate cut is announced. What if the cut doesn’t come as expected or is delayed indefinitely?

MARKETS HAVE PRICED IN THE EXPECTED CUT

The financial markets have risen significantly over the past two years. Stocks have recovered all of their previous losses resulting from the Fed campaign to increase interest rates, and are sporting new all-time highs almost daily. A rush to the exits could occur from disappointment over any further delay in rate cuts. Then, too, the actual announcement of a rate cut might trigger selling anyway, since the cut is already priced in.

There is another problem, too. A goodly portion of lofty stock index valuations are tied to a few extremely large cap tech stocks. That means that the majority of individual stocks don’t share proportionately in the gains of the index. That is Investors should understand clearly that continued financial and economic weakness or a severely deep recession, along with falling stock prices, could occur whether rate cuts are announced or not. 

Bond prices reflect the current level of interest rates. Interest rates are set in the bond market. To whatever extent bond traders or investors disagree with attempts by the Fed to raise or lower interest rates, they can bid prices higher or lower, as the case may be. For example, if the effects of inflation were to worsen considerably from this point, investors would demand higher returns to offset further risk from higher inflation. This translates to lower bond prices and higher interest rates, regardless of Fed desires and intentions.

RISKS THAT CAN’T BE IGNORED 

The lasting effects from the 2008 Great Recession were such that attempts by the Fed to pursue cheap and easy credit didn’t have the desired impact. It was more convenient and less risky for banks to park the extra money with the Fed than to lend it. During almost the entire decade leading up to Covid, a weakened economy seemed to ignore all attempts by the Fed, whose biggest concern was getting inflation back up to its 2% target. (see The Fed’s 2% Inflation Target is Pointless)

Over the decades, the desired impact of Fed policy continues to fall short of the mark (see Fed Inflation Is Losing It’s Intended Effect). Whatever the Fed’s intentions, and regardless of how logical the reasoning behind its actions and policies, the economy is slower to respond after each succeeding crisis. In addition, financial and economic volatility increases cumulatively.

The Federal Reserve creates bubbles (stocks in the 1920s; bonds 1982-2022; real estate 2000-2007; everything 2020-24) by intentionally expanding the supply of money and CREDIT – the cheap and easy kind. The bubbles always get popped. There again, the Fed is the culprit. In order to contain the collateral damage of their own profligate monetary policy, more intervention of a harsher nature is usually the answer. Notwithstanding the increase in rates over the past two years, the markets have risen as a result of expectations that the Fed will once again fall off the wagon and provide more cheap lubricant for overly optimistic and addicted investors.

When the Fed became concerned about the almost maniacal obsession with stock investing in the 1920s, it started clamping down on the cheap and easy credit that afforded banks the opportunity to lend as much as 90% of a potential investment to their eager and willing customers. The banks were just as eager and willing, too; until it was too late. The economy had begun to weaken many months before the stock market crashed. The Great Depression that followed lasted for more than a decade and was characterized by 20% unemployment, bank failures, trade tariffs, political instability, and world war in Europe.

CONCLUSION 

A rate cut is expected and desired by investors, consumers, and others; almost universally so. It is unlikely at this time that markets and the economy will respond with any vigor if/when that announcement is made. It is very likely that big surprises await those who think otherwise. The possibilities include a severe swoon in all markets which have risen in response to that expectation and as a result of any or all of the other factors mentioned in this article. In addition, there is the possibility that rates could be held at this level longer, or even raised, depending on the specifics of future events.

Rate cut or not, what happens after will not be as expected or intended. (also see Interest Rate Cuts – Salvation Or Damnation?)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

Descending Price Peaks In Latest Gold Charts

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The latest gold charts are pictured below and show a series of descending price peaks dating back to 1980. There are four charts. The first two charts are for the period following the August 2011 peak. The third and fourth charts are for the period after the gold price peaked in 1980. Prices on all charts are monthly average closing prices.

For example, the average closing price for gold in the month of January 1980 was $677 oz. This price ($677) is shown on Chart #3 below. During that same month, the intraday high for gold was $843 oz. The spike in price above $800 was very short-lived and not a reliable indicator of where gold traded during the month of January 1980. Average closing prices are more representative and more realistic for comparative purposes and analyses.

There are two charts for each time period. The first chart plots nominal prices; the second chart shows inflation-adjusted prices. Here is the first chart…

#1 Gold Prices August 2011-June 2024

The average closing price for gold in August 2011 was $1825 oz. After declining for more than four years, the gold price bottomed at $1060 oz. and began rising. The 2011 high was eclipsed and a new high price for gold was set at $1971 oz. in July 2020. After a sharp decline in 2022, the price of gold rose to another new high of $2327 oz., which is also the current closing price on June 28, 2024. The gold price has more than doubled (119%) since its December 2015 low.  That is quite impressive, but, there are some caveats.

Gold’s recent price performance, in total, looks very good if you are short-term oriented. The shouts of joy might be a bit overdone, though, if you have been holding gold since its peak in 2011. In that case, the total price increase for the entire thirteen-year period is only 27%. That is an annualized gain of 1.86%, which is more indicative of a slow-moving wagon, rather than a rocket ship in blastoff mode.

The numbers in both cases are made worse when the effects of inflation are factored in…

#2 Gold Prices (inflation-adjusted) August 2011-June 2024

In Chart #2, the effects of inflation have turned the 2011 high and subsequent new highs in 2020 and 2024 into a series of descending peaks. Each successive peak almost matches, but doesn’t quite reach the previous high point. The total gain of 119% referenced in Chart #1 is almost halved, down to 66%. The meager nominal price increase of 27% is now a net loss (-8%). The $1825 oz. nominal price peak in 2011 correlates to a real (inflation-adjusted) price of $2529 oz. in today’s cheaper dollar(s),

Now, let’s look at gold’s price performance over a longer time period. Here is Chart #3…

#3 Gold Prices January 1980-June 2024

When the gold price peaked in January 1980, it correlated to the effects of inflation that had depleted U.S. dollar purchasing power by 97% over the previous half-century. At $677 oz., the gold price was thirty-three times higher than it was when gold and the dollar were interchangeable, i.e., convertible, at a fixed ratio of $20.67 per ounce. The next major peak for the gold price was in 2011 at $1825 oz., followed by 2020 and 2024. Now, lets look at inflation-adjusted prices dating back to 1980…

#4 Gold Prices (inflation-adjusted) January 1980-June 2024 

In Chart #4, the ever-ascending nominal price increases shown previously in Chart #3 are more severely subdued when the effects of inflation are factored in. In addition, both volatility and time become more apparent.  While the nominal price of gold continues to rise reflecting actual loss of purchasing power in the U.S. dollar, the gold price in real (inflation-adjusted) terms has yet to exceed any of its previous price peaks; and likely never will. That is because gold’s value is in its use as money and is basically constant.

Each price peak in gold beginning in 1980 and including the peaks in 2011, 2020, and 2024 is a reflection of the intervening loss of purchasing power in the U.S. dollar since the previous peak.

CONCLUSION 

After allowing for the effects of inflation, an ounce of gold at $2400 today is no more valuable than it was at $2000 in 2020, or $1825 in 2011, or $677 in 1980. For that matter, the purchasing power of one ounce of gold is the about the same today as it was a century ago when it was priced at $20.67. In other words, if you bought gold at any of those prices and held it until now, you do not have real profits. The higher gold price is not a profit. It represents the dollar’s loss of purchasing power. (There are possible short-term trading opportunities for traders. See Understanding Profit Potential In Gold)

Gold is real money and a long-term store of value. Holding gold provides a measure of protection against depreciating currencies. Over time, the increasing price of gold matches the loss of purchasing power in the U.S. dollar that has already occurred. (also see Gold Has Done It’s Job – Isn’t That Enough?)

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED

“And So Rates Will Be Higher”- Jerome Powell

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Jerome Powell says “rates will be higher”. I believe him. I don’t think most others do. Investors, especially, need to pay attention.

FED POLICY

I have read the text of Powell’s interview. His comments are consistent with remarks he has made over the past two years during the Fed’s  current campaign to see interest rates returned to a higher, more historically normal level…

“I think instinctively – I can’t prove this, we’re going to learn about this empirically – but it seems to me that the neutral rate is probably higher than it was during the intra-crisis period. And so, rates will be higher.” 

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Interest Rate Cuts – Salvation Or Damnation?

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The anticipation and speculation regarding interest rate cuts is almost comical to watch. Scratch ‘almost’. Interested observers are obsessive about the topic in a hilariously funny way. Mainstream media and the pundits always find cause for promoting a possible rate cut no matter what is said. (see Investors Re: Rate Cuts)

The expectation for at least one cut of 1/4 point before the end of this year seems to be nearly universal, so let’s go with that for now. Here are some questions for consideration.

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Bank Stress Test Results Are Just Window Dressing

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  • window dressing: an adroit but superficial or actually misleading presentation of something, designed to create a favorable impression.
    “the government’s effort has amounted to little more than window dressing” (Oxford Languages)

BANK STRESS TESTS – FEELING GOOD AND TALKIN’ THE TALK

The Federal Reserve recently reported the results of its annual economic stress tests for banks. The test supposedly indicates how banks can be expected “to perform under certain hypothetical economic conditions.”

The reason it is termed a stress test is because the hypothetical conditions are negative in nature…

“The 2024 stress test shows that the 31 large banks subject to the test this year have sufficient capital to absorb nearly $685 billion in losses and continue lending to households and busi- nesses under stressful conditions.” Executive Summary @ federalreserve.gov

The June 26, 2024 press release stated that the “Federal Reserve Board annual bank stress test showed that while large banks would endure greater losses than last year’s test, they are well positioned to weather a severe recession and stay above minimum capital requirements“.

This year’s test was modified to be more stringent in order to reflect the possibility of more severe liquidity problems for banks in light of numerous bank failures experienced last year, highlighted by Silicon Valley Bank (SVB). Below is how the matter was addressed by Fed Chair Jerome Powell at that time…

“So, I guess our view is that the banking system is sound and it’s resilient—it’s got strong capital [and] liquidity. We took powerful actions with [the] Treasury and the FDIC, which demonstrate that all depositors’ savings are safe and that the banking system is safe.Mar 22, 2023 

The statement was a bit premature as other banks subsequently failed. Anxiety was calmed however, and fears were tempered. A followup statement by Chair Powell provided additional reassurance…

“The U.S. banking system is sound and resilient, with strong levels of capital and liquidity. (Powell, July 23, 2023)

QUESTIONS AND CONCERNS 

What if conditions are worse than those simulated in the stress tests? In financial and economic matters, it most always seems to be that way. The current stress test parameters allow for declining interest rates. The Fed may want to see rates lowered in a crisis, but wholesale dumping of worthless credit obligations would send interest rates through the roof. We saw that in 2008 with residential mortgages specifically and bonds in general. The Fed might not be able to stem the tide with purchases for their own account as they did then.

Banks are notoriously illiquid. There are no reserve requirements. The 10% fractional-reserve requirement based on total bank deposits was eliminated several years ago. That’s not much, but, at least it provided a measure of (il)liquidity and a margin of solvency. For example, if a bank has $1MM in deposits and lends out $900,000, the remaining $100,000 is still available to meet withdrawal demands. Now that the reserve requirement has been eliminated, it is not unrealistic to assume that some (or, most) banks probably have loaned out more money than they have in total deposits. In other words, there are no reserves, so how can a bank be expected to meet net outflows/withdrawal demand?

The reserve requirement was eliminated for two reasons: 1) to support efforts to flood the economy with money in response to the forced Covid shutdown and resumption of economic activity afterwards and 2) most banks were probably in danger of violating the existing 10% reserve requirement; remove the requirement and the problem goes away – for a little while, maybe. (see more about fractional-reserve banking)

The banks aren’t satisfied, though. They want less stringent requirements.

CONCLUSION

The extent and duration of pending financial and economic crises will be worse than any previous ones. The events themselves and their negative effects will confirm that bank stress tests and their results are inadequate, unreliable, and virtually worthless.

Kelsey Williams is the author of two books: INFLATION, WHAT IT IS, WHAT IT ISN’T, AND WHO’S RESPONSIBLE FOR IT and ALL HAIL THE FED!