Fed pivot

Investors Re: Rate Cuts – “So You’re Telling Me There’s A Chance”

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INVESTORS AND RATE CUTS

When it comes to cuts in interest rates, investors stubbornly cling to the notion that “no” means “yes”. In the movie, Dumb And Dumber, Lloyd Christmas (Jim Carrey) asks the lovely lady he is pursuing what the odds are that the two of them might get together; and, makes a point of telling her to “give it to me straight”. She replies “not good”. She further clarifies that the actual odds are “more like one in a million”. Not to be deterred, Carrey, in character, replies “So you’re telling me there’s a chance”. Here is the clip https://www.youtube.com/shorts/cbrTKw50X6U

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Investors Are Too Anxious For Rate Cuts

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INVESTORS ARE TOO ANXIOUS FOR RATE CUTS

Anxious investors seem to be expecting more than has been “promised” regarding interest rate cuts. Some (quite a few) seem overconfident that the long awaited pivot is a done deal. In addition, anticipated results from the expected cuts are already built into the markets to a large degree. Here are some thoughts worthy of consideration…

1) Suppose the Fed cuts rates later this year, but not as much as expected. Is cutting interest rates 1/4 or 1/2 percent all that is necessary to kick the gravy train into high gear?

2) Is a Fed pivot a temporary thing? Maybe the Fed cuts a quarter point once or twice, then re-pivots and begins raising rates anew.

3) What if the Fed doesn’t cut rates at all?

ANTICIPATION IS MAKING ME WAIT

(Thank you, Carly Simon, for the perfect subheading.) The possibility of three rate cuts in 2024 has been amplified to mean that the Fed will cut rates this year – 2024. The rate cuts most everyone is expecting are the same rate cuts that were assumed and expected for most of last year – 2023. Isn’t it possible that rate cuts could be postponed again? How long can elevated stock prices and other assets maintain their lofty levels based on the expectation of lower interest rates which continue to be expected but not realized?

IF THE FED PIVOTS, MIGHT IT BE TEMPORARY? 

Overlooked in the rush by everyone outside of the Federal Reserve to talk interest rates down are comments by Fed Chair Powell which include the phrase “higher for longer”. Those who are so intent on expecting lower interest rates might do well to consider not just the possibility, but the likelihood of rates remaining higher for longer. 

Rates were intentionally forced lower by the Federal Reserve over nearly four decades prior to the official announcement their campaign to raise interest rates in March 2022. During those four decades the Fed moved back and forth both higher and lower regarding interest rates, but all changes in direction were temporary within a long-term decline in rates lasting nearly forty years.

The emphasis on “lower for longer” took interest rates close to zero and created an addiction for cheap money and credit. The artificially low interest rates that fueled the addiction were not normal. They were abnormally low historically and created huge bubbles in asset prices. Financial and economic volatility increased and the U.S. dollar suffered a loss of credibility and purchasing power.

As a result, the Fed was forced to change its interest rate policy to protect and defend the dollar. Not out of a patriotic sense of duty, but in order to save the financial system. It may be too late for that.

That brings us to our final point. What if the Fed doesn’t cut interest rates?

WHAT IF THE FED DOESN’T CUT RATES?

It is very much a possibility that the Fed might not cut rates at all. The inclination to do so seems to change from week-to-week and month-to-month along with changing economic data and statistics. Jerome Powell has been consistent in his comments that “higher for longer” is the game plan. Maybe rates get kept at current levels for awhile longer.

At their current level, interest rates are still abnormally low on a historic basis. Historically normal interest rates average 7-8 percent. We are not there yet. And with the extreme lows for interest rates experienced for several decades, there is a significant amount of inefficient allocation of money and resources that needs to be reallocated. That will result in varying degrees of financial and economic pain.

CONCLUSION 

The Federal Reserve has a history of market intervention and manipulation. The Fed’s interest rate policy is a manipulation ‘tool’. The market intervention and manipulation is ongoing. The overriding purpose is to create and sustain an environment that enables banks to continue to lend money and collect interest in perpetuity.

Often, though, application of the ‘tool’ is a defensive reaction to unintended and unexpected financial and economic events. For many years now, the Fed has been occupied with battling the negative consequences of it previous policies and actions. They may be in the driver’s seat, but the vehicle is out of control.

Stormy seas are ahead. If the Fed cuts too soon or too much, the cheap bubble juice will create more inefficiencies and extreme volatility. Right now, just the expectation of a return to cheap and easy money/credit has blown bubbles in almost everything priced in dollars. At some point, bubbles get popped. That is something the Fed is trying to avoid.

Interest rate cuts are not a sure thing. Investors could be in for a nasty surprise. (also see Federal Reserve and Market Risk)

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!

Viewing Gold In Its Proper Context

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Viewing gold in its proper context seems to be difficult for most gold bugs. The excitement associated with anticipation of gold at $3000, $10,000, or higher tends to overide real fundamentals and common sense.

Not a few of the predictions for a new, higher gold price are just wild guesses. Some of the reasons given to support those guesses include a Fed pivot and reduction in interest rates, geopolitical concerns, a recession and weak economic activity, and a collapse in the U.S. dollar. There are others, but for now, lets look at these.

GOLD AND INTEREST RATES 

Financial writers in the media continue to refer to “gold’s correlation with interest rates”. The theory is that higher interest rates are negative for gold (the gold price) because gold doesn’t pay interest. Hence, investors tend to shun gold when interest rates are rising and look elsewhere for a higher return.

Time and again, the following statement or something similar finds its way into gold commentary:

“…prospects of higher US interest rates have the ability to limit upside gains. It must be kept in mind that Gold is a zero-yielding asset that tends to lose its allure in a high-interest rate environment”  

A variation of that statement:

“Because gold doesn’t bear interest, it struggles to compete when interest rates rise.” 

The statements imply a correlation between gold and interest rates. The implied correlation suggests that higher interest rates result in lower gold prices, however…

Between 1970 and 1980, the price of gold increased from $35.00 per ounce to $850.00 per ounce. Rather than declining, though, interest rates were rapidly rising.

Gold galloped ahead in the face of ever higher interest rates and increasing lack of demand for higher-yielding investments including U.S. Treasury Bonds. The 10-year U.S. Treasury bond yield exceeded 15%!!! This contrasts markedly from what happened thirty years later.

During the ten-year period 2001-2011, the price of gold increased from $275.00 per ounce to a high of almost $1900.00 per ounce. Yet, interest rates, which had been declining since the 1980s, continued  their descent (helped along by the Fed, of course).

Two ten-year periods of outsized gains in the price of gold while interest rates were doing something exactly opposite during each period. There is no correlation between gold and interest rates.

GOLD AND GEOPOLITICAL CONCERNS 

Any apparent effects from geopolitical issues are temporary at best, and there is no reason to expect them to have any measurable or lasting impact on the gold price unless the U.S. dollar is affected negatively.

(See my article The Gold Price And Geopolitical Concerns for examples; i.e., Russia vs. Ukraine, Israel vs. Hamas, The War with Iraq, etc.).

GOLD AND RECESSION FEARS

A recession is a period of weak economic activity. Even a severe recession will not have an appreciable effect on the gold price.

If the recession deepens and economic activity declines severely,  the result could be a full-scale depression.

In most cases, events of this nature are accompanied by deflation. Deflation is the opposite of inflation and results in a stronger currency (USD) which gains in purchasing power.

The gain in purchasing power means you can buy more with your dollars – not less. The downside is that there are fewer dollars to go around. There would be a huge price collapses in prices for all assets, investments, goods and services. The gold price would be similarly affected.

GOLD AND DOLLAR COLLAPSE 

There are expectations by some for a complete collapse in the U.S. dollar resulting in hyperinflation; similar to Germany in the 1920s, Zimbabwe, or Venezuela.

That is possible, but it is unlikely.  A credit collapse and deflation are more likely since the Federal Reserve fuels inflation with cheap credit. A credit collapse would trigger huge price declines in all assets, including gold. The most likely result would be a full-scale depression that could last for years.

Even if the U.S. dollar were to collapse, the price of gold in dollars would be meaningless.

VIEWING GOLD IN ITS PROPER CONTEXT 

Gold is real money and a long-term store of value. It is also original money. Gold was money before the U.S. dollar and all paper currencies; and, all paper currencies are substitutes for gold, i.e., real money.

The higher price of gold over time reflects the ongoing loss of purchasing power in the U.S. dollar. In other words, the price of gold tells us nothing about gold.

The gold price tells us only what has happened to the U.S. dollar. The same thing is true if gold is priced in any other fiat currency.

Over the past century, the dollar has lost ninety-nine percent of its purchasing power. This means that it costs one hundred times more for the things you buy today than it would absent the effects of inflation.

The original fixed price of gold was $20.67 oz. Convertibility allowed exchange of $20.00 in paper money for one ounce of gold and vice versa.

At $2000 oz., gold today is one hundred times higher and reflects the actual ninety-nine percent loss of USD purchasing power.

The gold price only moves higher to reflect the dollar’s loss of purchasing power after the fact;  never before.

Expectations for a much higher gold price based on anything other than the loss of U.S. dollar purchasing power will not be realized.

A much higher gold price can only present itself after further, significant loss of U.S. dollar purchasing power.

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!