Fed policy Dead End

Posted By Darren Winters on May 20, 2024

Fed policy Dead End

Has the Fed policy dead end been reached? 

If the Fed decides to lower interest rates, they will get more paper wealth as a stock and bond rally takes hold. 

However, some argue that the bond rally in a rate-cut scenario would be short-lived because bond investors will view it as an opportunity to dump more treasuries at a better price than two months ago.

The rejection of treasury bonds by foreigners who may decide not to show up for bond auctions could play out. 

This scenario could see a paper explosion, a crackup boom, or a melt-up in risk assets. 

Fed policy dead-end with raising rates could see a repeat of the 2023 bond market crash, the worst in history

Another bond market crash would be detrimental.  T Bonds are  perceived as a safe haven asset, used by commercial banks as collateral to raise loans. A bond market crash  would trigger a historic credit crisis many times worse than the 2008 financial crisis, a niche debt crisis in the subprime mortgage market.

We could see a return of the 2023 bank runs and subsequent five bank failures, repeated in the US and globally. 

Moreover, because inflation is not caused by demand, bear in mind that US households are broke using their credit cards to buy essentials such as groceries.

FED policy dead end

Only one in three Americans have $400 to cover emergency expenses.

So increasing interest rates would be counterproductive, as it would trigger stagflation, a situation where inflation keeps rising and economic output falls.

Investors would reject further bonds as the interest payment on the 34 trillion dollar public deficit would spiral above the current 1.2 trillion annual borrowing costs.  

Bond yields would keep rising, pushing up the cost of credit even further in a slowing and highly leveraged economy, with the likely outcome being a tsunami of loan defaults in the private and public sectors.  

In an attempt to stop bond yields from shooting higher and causing a global banking collapse mad max situation, the Fed will most likely start its bond purchase programme, QE. 

But QE to infinity leads to hyperinflation, with perhaps Argentina giving us an insight into the future, a hyperinflationary depression. 

Fed policy has hit a dead end, as they need to cut and raise rates, and since they can’t do both, they are now gaming it

Speculation on what the Fed may do next as Fed policy has hit a dead-end 

A replay of the ’70s stagflation, playing the stop-start, to cut, and not to cut policy of that era, looks to be underway.

November 2023 the bond market crash meant treasury bond portfolios were down some 30 to 40%, and banks were insolvent and in trouble. 

So the Fed decided to trigger a bond rally by talking about rate cuts.

The Fed talked about rate cuts by saying they needed to stimulate the economy from the threat of a worsening depression.

Then what followed over the next two months was maybe we might not do a rate cut just yet. 

In February, inflation was returning, which entailed removing rate cuts.

Then, in March, they said they would pay more attention to the unemployment rate. 

As unemployment started rising that put rate cuts back on the table.

The most recent development is that central banks around the world are cutting rates, the Swiss National Bank kicked off the rate-cut cycle from 1.75% to 1.50%. The European Central Bank made it clear rate cuts are coming in June, Bank Of England is forecast to cut its interest rate in August. There is also a 67% chance Bank of Canada will cut rates in June.

In short, the Fed and its Western banks are forecast to begin in tandem a new credit loosening cycle in the Summer of 2024.  

An aligned central bank loosening policy creates the illusion of stability in currencies and hides currency debasements. 

However, some argue that a globally aligned loosening policy won’t work because the US stands apart with its massive deficit, increasing by 1 trillion dollars every hundred days. 

Fed policy dead-end, what are the likely scenarios? 

One scenario is a short-duration loosening cycle with one or two rate cuts, but it doesn’t yield much of a bond and stock rally.  

What happens if nobody shows up at the bond auctions and there is a wave of new debts needing to be monetized? 

So, they go back to hiking?

If so, rates end up higher than what they were.

Scenario two; many rate cuts and bonds rally and attract new investors into the bond market.

But what if bond investors use the rally to get out of treasuries, and then   

Nobody shows up to the bond auctions, and there is a surplus of 9 trillion treasury bonds maturing this year that must be funded? 

If that oversupply of bonds is bought with Fed central bank currency creation that will cause price inflation. 

Fed policy dead-end politicising bond buying 

Scenario three is ugly, depression and WW3 

We have an inflationary depression. Monetary policy cannot focus on solving the inflation problem and the labour market unemployment.. 

If financial common sense doesn’t make investors buy treasuries, ideology will.

All that you would expect preluding a global war is occurring, the expulsion of diplomats, and assassination attempts of leaders with both sides reconfiguring into wartime economies.

Both sides are preparing for war.

Russia’s new defence minister is a technocrat, a civilian economist who will nationalize the military-industrial complex into a Soviet communist-style planned economy. 

State-owned institutions, resources owned by the state, not private stockholders, and managed by technocrats, are running the war machine.

Last month, the US federal government announced approximately 100 billion dollars to fund multi-front wars in east-front Europe and the Middle East. 

The military-industrial complex will be on the receiving end of most of those funds.

“Freedom bonds” have politicised bond investing. 

The war is also becoming an ideological battle between two opposing economic systems, private stockholder capitalism versus state-controlled central planning.  

Wealth Westerners and the guardians of wealth will back private ownership and buy freedom bonds because it is in their self-interests to do so.

If the above is true, politics could drive the next wave of bond buyers and not finance.  

Submit a Comment

Your email address will not be published. Required fields are marked *

Subscribe to my Investment Newsletter and receive the FREE video:  3 OF DARREN’S BEST INVESTMENT STRATEGIES

You have Successfully Subscribed!

Pin It on Pinterest

Share This

Share This

Share this post with your friends!