“If There’s a Recession, Don’t Worry”

This post “If There’s a Recession, Don’t Worry” appeared first on Daily Reckoning.

“Pride goeth before destruction,” warns the Book of Proverbs… “and a haughty spirit before a fall.”

The Federal Reserve might keep this biblical reproach close by…

For as one Federal Reserve magnifico boasted recently — pridefully and haughtily:

“If there’s a recession, don’t worry.”

Don’t worry, that is, because “the Fed is very powerful.”

This information we gathered through our vast web of spies…

Dispatch From a Banking Conference in Puerto Rico

The Federal Reserve hosted a recent banking conference on the Caribbean island of Puerto Rico.

Old Daily Reckoning hand and “sovereign man” Simon Black dispatched an agent to listen in… who wired back the transcript.

Says Simon, via his man in San Juan:

One very senior Fed official… told the audience, “If there’s a recession, don’t worry,” because “the Fed is very powerful” and has all the tools it needs to support the economy.

To which instruments of power does this grandee refer?

We have no specific information. But interest rates cannot be among them…

The Fed Has Limited “Strategic Depth” to Fight Recession

History argues the Federal Reserve requires rates of 4% or 5% to vanquish a recessionary foe.

Only these elevated rates give it the “space” to slash rates sufficiently — to zero if necessary.

But today’s federal funds rate ranges only between 1.50% and 1.75%.

Thus the central bank’s last trench line — the zero bound — lies dangerously close in back of it.

That is, the Federal Reserve presently lacks the strategic depth to mount a successful rate-based defense… and wear down the enemy in its protracted meat grinder.

Should the enemy puncture the Fed’s shallow defenses, the vast rear is currently open to it. And recession would have the entire economy in siege.

What weapons, then, might remain in the Federal Reserve’s arsenal?

Additional quantitative easing? Perhaps “forward guidance”? They are on hand, yes.

But what about negative interest rates, previously confined to the drawing board? Why make the zero bound your last line of defense?

Why not stretch the barbed wire behind it, lay down mines… and dig additional trenches in negative territory?

Negative rates would deepen and stiffen the defense, their boosters argue.

Three Full Percentage Points!

Former Federal Reserve Field Marshal Ben Bernanke insists these are formidable anti-recession armaments. He sets great store by them, in fact.

Quantitative easing, forward guidance and negative interest rates — combine them one with the other, says this strategic genius…

And they equal three full percentage points of rate cuts. Three full percentage points!

By his lights then, today’s federal funds rate is not as low as 1.50% — but as high as 4.75%.

That is… the Federal Reserve presently enjoys nearly all the strategic depth required to fight back recession.

We suppose these are the weapons our anonymous central banker has in mind — those that render the central bank “very powerful.”

But we are not half so convinced. We see not an impregnable defense… but a Maginot Line, vulnerable to a superior strategy.

We envision a flanking attack, with enemy armor snaking its way through the Ardennes, bypassing the forts.

We further envision a thrust through the Moselle Valley… and into the defenseless economic interior.

The Fed’s Weak Defenses

Place no faith in the Federal Reserve’s Maginot Line, argues Jim Rickards:

Here’s the actual record…

QE2 and QE3 did not stimulate the economy at all; this has been the weakest economic expansion in U.S. history. All QE did was create asset bubbles in stocks, bonds and real estate that have yet to deflate (if we’re lucky) or crash (if we’re not).

Meanwhile, negative interest rates do not encourage people to spend as Bernanke expects. Instead, people save more to make up for what the bank is confiscating as “negative” interest. That hurts growth and pushes the Fed even further away from its inflation target.

What about “forward guidance”?

Forward guidance lacks credibility because the Fed’s forecast record is abysmal. I’ve counted at least 13 times when the Fed flip-flopped on policy because they couldn’t get the forecast right.

So every single one of Bernanke’s claims is dubious. There’s just no realistic basis to argue that these combined policies are equal to three percentage points of additional rate cuts.

Fighting the Last War

Generals prepare to fight the last war, it is often argued. We suppose central bankers prepare to fight the last crisis.

Meantime, the relentless enemy is preparing to wage the next recession. It learns, it adapts. It originates new tactics, new weapons… new strategies.

It bypasses Maginot Lines.

And so we expect the next recession to catch our hidebound central bankers unaware… facing straight ahead while the tanks roll in from their flank.

But we expect a new war plan to emerge from the next recession, once all existing defenses are flat.

The New Wonder Weapon

At its center will be the wonder weapon of Modern Monetary Theory, or MMT.

Up it will go in its Enola Gay… and the fiscal authorities will unload it high above Main Street.

Cash will come raining down upon the unsuspecting residents below, like so much confetti.

They will then vanish into stores, into restaurants, into theaters to disgorge their newfound bounty.

The secondhand recipients of this bounty will proceed to exchange it for autos, boats and houses.

The third-hand recipients will in turn send the money on its way, fanning out in greater circles yet.

The entire economy would soon be on the jump… and recession thrown headlong into rout, permanent and humiliating rout.

But this super-weapon packs greater wallop yet…

Everything for Everyone

It can furnish the wherewithal for a “Green New Deal,” universal health care, free college for all… and guaranteed employment.

If John is unemployed, if Jane cannot meet tuition, if Joe lacks health care… then simply print the money to make them whole.

Send it marching off for duty in the general economy, where it will make all shortages good.

MMT says unemployment, for example, is direct evidence that money is overtight.

Print enough and you have the problem licked.

But didn’t the government print money like bedlamites after the financial crisis? How can money possibly be tight?

Ah, but QE’s trillions were funneled off into credit markets, where they liquified the financial system.

They did not enter the Main Street economy. That is why inflation never got its start.

But with MMT, the money goes straight from the print press to the Treasury.

It can then be spent into public circulation — on a New Deal, for example. Green, red, blue, purple or pink… the choice is yours.

Or for free college, universal Medicare… jobs for all.

But you raise an objection. MMT is a cooking recipe for massive inflation, you say… even hyperinflation.

Inflation? No Problem

Yes, but the MMT crowd has anticipated your objection and meets you head on.

They actually agree with you. They agree MMT could cause a general inflation, possibly even a hyperinflation.

In fact, inflation is the one limiting factor they recognize, the one potential monkey wrench jamming the gears.

But they have the solution: taxation.

If inflation begins to bubble, to gurgle, the government can simply drain the excess dollars out of the system.

Under MMT the economy is the tub. Taxation is the drain.

Under the theory, in fact, stifling inflation is taxation’s central purpose. It is not to raise revenue.

“Ignoring It Would Be Foolish”

Is the theory crackpot? Yes, we are convinced it is.

But desperate times invite desperate measures. And when recession rolls on through the Federal Reserve’s defenses… desperate measures we will see.

We cannot say when of course. Nonetheless…

“[It] is coming,” warns analyst Kevin Muir. “Ignoring it would be foolish.”

Yet these are foolish times…  inhabited by foolish people.

Do you require proof?

Simply recall the recent counsel of a senior Federal Reserve official:

“If there’s a recession, don’t worry.”

Regards,

Brian Maher
Managing editor The Daily Reckoning

The post “If There’s a Recession, Don’t Worry” appeared first on Daily Reckoning.

Time to give Powell Truth Serum

This post Time to give Powell Truth Serum appeared first on Daily Reckoning.

The coronavirus has gone… “viral.” At the very least its media coverage has.

You may have therefore missed the news yesterday:

The Federal Reserve concluded its January FOMC meeting. It thereupon announced it is holding interest rates steady.

The federal funds target rate stays sandwiched between 1.50% and 1.75%.

Jerome Powell gave off his usual post-announcement whim-wham. He talked a lot, that is… but did not say much.

Example: A reporter rose before him with a question…

He asked the chairman if he feared withdrawing support for the “repo” market. The stock market may file a vigorous protest if he does, the implication being.

Powell came back at him this way:

In terms of what affects markets, I think many things affect markets. It’s very hard to say with any precision at any time what is affecting markets.

Yet here is the very picture of precision:

IMG 1

Here, once again, the precise union between the Federal Reserve’s balance sheet and the S&P 500.

The two have gone happily arm in arm, linked, since early October.

Yet a Federal Reserve chairman must master the artful dodge, the skill to pretend ignorance of the most elemental facts — even the evidence of his own eyeballs.

Imagine the scene…

You enter a dining room for your evening meal. Jerome Powell is by your side.

You are astounded to discover a behemoth draft horse lounging upon the dining table. Stunned, ruffled, gobsmacked, you solicit comment from your dining mate…

“What horse?” asks he. “I don’t see a horse.”

Do we condemn the chairman? Do we impugn him, belittle him, call him into ridicule?

No. We are actually in deep sympathy with him. What — after all — is this fellow to say?

Is he to concede that the stock market is a house constructed of playing cards… and that he is its foundation?

That it would come heaping down without his determined and continuous support?

An honest answer would take the floor out of a vast fiction — the vast fiction that the stock market goes by itself, that its own pillars hold it up.

Dose him with C11H17N2NaO2S — that is, dose him with sodium pentothal — that is, dose him with truth serum…

And the ensuing geyser of honesty would collapse the Wall Street stock exchanges… as surely as the ancient Israelites collapsed the walls of Jericho.

Here is a brief sample of what Mr. Powell would confess under chemical influence:

That he is a mediocrity, a blank, a preposterous formula…

That he is far out of his depth…

That he is as fit to chair the Federal Reserve’s board of governors as he is to chair a board of barbers…

That he cannot tell you the next quarter’s GDP at the price of his soul…

That his enflamed hemorrhoids torture him ceaselessly…

That he cannot possibly determine the proper interest rate for millions upon millions of independent economic actors…

That he wields far less influence over interest rates than commonly believed…

That the president of the New York Fed smells…

That there is no actual money in monetary policy…

That he clings yet to his boyhood fantasy of becoming a salesman of life insurance…

That his wife’s cooking is a daily source of agony…

That his — no, no — we had better stop here. Some truths must remain dark. That counts double for a man of Mr. Powell’s high station.

Instead, the good chairman will babble what the world wants him to babble. Like this, for example, from yesterday:

The committee judges that the current stance of monetary policy is appropriate to support sustained expansion of economic activity, strong labor market conditions and inflation returning to the committee’s symmetric 2% objective.

Or this, also from yesterday:

[The] labor market continues to perform well… We see strong job creation, we see low unemployment [and] very importantly we see labor force participation continuing to move up.

And this:

Some of the uncertainties around trade have diminished recently and there are some signs that global growth may be stabilizing after declining since mid-2018.

Does Mr. Powell believe the words issuing from his own mouth? We are far from convinced.

Perhaps it truly is time to fill him with sodium pentathol…

Below, Jim Rickards shows you why the happy talk is simply that, and why the Fed has “never been more divided.” Read on.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post Time to give Powell Truth Serum appeared first on Daily Reckoning.

5,000 Years of Interest Rates, Part II

This post 5,000 Years of Interest Rates, Part II appeared first on Daily Reckoning.

Yesterday we hauled out evidence that interest rates have gone persistently down 500 years running.

And the high interest rates of the mid- to late 20th century?

These may be history’s true aberration, a violent but brief lurch in the chart… like a sudden burst of blood pressure.

Let us here reintroduce the graphic evidence:

IMG 1

Here is an extended picture of downward-trending rates — with the fabulous exception of the mid-to-late 20th century.

As Harvard economics professor Paul Schmelzing reckoned yesterday, as summarized by Willem H. Buiter in Project Syndicate:

Despite temporary stabilizations such as the periods 1550–1640, 1820–1850 or in fact 1950–1980… global… real rates have persistently trended downward over the past five centuries…

Can you therefore expect the downward journey of interest rates to proceed uninterrupted?

We have ransacked the historical data further still… rooted around for clues… and emerged with worrisome findings.

Why worrisome?

Details to follow. Let us first look in on another historical oddity, worrisome in its own way — the present stock market.

A Lull on Wall Street

It was an inconsequential day on Wall Street. The Dow Jones took a very slight slip, down nine points on the day.

The S&P scratched out a single-point gain; the Nasdaq gained 12 points today.

Gold and oil largely loafed, budging barely at all.

Meantime, humanity’s would-be saviors remained huddled at Davos. There they are setting the world to rights and deciding how we must live.

But let us resume our study of time… and money.

For light, we once again resort to the good Professor Schmelzing.

The arc of interest rates bends lower with time, he has established. But as he also establishes… no line bends true across five centuries of history.

Put aside the drastic mid-to-late 20th century reversal. Even the long downturning arc has its squiggles and twists, bent in the great forges of history.

To these we now turn…

“Real Rate Depression Cycles”

Over seven centuries, Schmelzing identifies nine “real rate depression cycles.”

These cycles feature a secular decline of real interest rates, followed by reversals — often sudden and violent reversals.

The first eight rate depression cycles tell fantastic tales…

They often pivoted upon high dramas like the Black Death of the mid-14th century… the Thirty Years’ War of the 17th century… and World War II.

IMG 2

The world is currently ensnared within history’s ninth rate depression cycle. This cycle began in the mid-1980s.

Schmelzing says one previous cycle comes closest to this, our own. That is the global “Long Depression” of the 1880s and ’90s.

This “Long Depression” witnessed “low productivity growth, deflationary price dynamics and the rise of global populism and protectionism.”

Need we draw the parallels to today?

It is here where our tale gathers pace… and acquires point.

A Thing of Historic Grandeur

Schmelzing’s research reveals this information:

This present cycle is a thing of historical grandeur, in both endurance and intensity.

Of the entire 700-year record… only one cycle had a greater endurance. That was in the 15th century.

And only one previous cycle — also from the same epoch — exceeded the current cycle’s intensity.

By almost any measure… today’s rate depression cycle is a thing for the ages.

Turn now to this chart. The steep downward slope on the right gives the flavor of its fevered intensity:

IMG 3

Schmelzing’s researches show the real rate for the entire 700-year history is 4.78%.

Meantime, the real rate for the past 200 years averages 2.6%.

Beware “Reversion to the Mean”

And so “relative to both historical benchmarks,” says this fellow, “the current market environment thus remains severely depressed.”

That is, real rates remain well beneath historical averages.

And if the term “reversion to the mean” has anything in it, the world is in for a hard jolt when the mean reverts. Why?

Because when rates do regain their bounce — history shows — they bounce high.

Schmelzing:

The evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable… Most reversals to “real rate stagnation” periods have been rapid, nonlinear and took place on average after 26 years.

Twenty-six years? The present rate depression cycle runs to 36 or 37 years. We must conclude it goes on loaned time. What happens when the loan comes due?:

Within 24 months after hitting their troughs in the rate depression cycle, rates gained on average 315 basis points [3.15%], with two reversals showing real rate appreciations of more than 600 basis points [6%] within two years.

The current rate depression cycle ranges far beyond average.

It is, after all, the second longest on record… and the second most intense.

If the magnitude of the bounceback approximates the magnitude of the cycle it ends… we can therefore expect a fantastic trampolining of rates.

That is, we can likely expect rate appreciations of 6% or more.

What Happens When Rates Rise?

The stock market and the decade-long economic “recovery” center upon ultra-low interest rates. And so we recoil, horrified, at the prospect of a “rapid, nonlinear” rate reversal.

We must next consider its impact on America’s ability to finance its hellacious debt…

A violent rate increase means debt service becomes an impossible burden.

How would America service its $23 trillion debt — a $23 trillion debt that jumps higher by the minute?

Debt service already represents the fastest-growing government expense.

Interest payments will total $460 billion this year, estimates the Congressional Budget Office (CBO).

CBO further projects debt service will scale $800 billion by decade’s end.

$800 billion exceeds today’s entire $738 billion defense budget. As it exceeds vastly present Medicare spending ($625 billion) and Medicaid spending ($412 billion).

CBO Doesn’t Account for Possible End to Rate Depression Cycle

But CBO pays no heed to the rate depression cycle. It — in fact — projects no substantial rate increases this decade.

But what if the present rate depression cycle closes… and interest rates go spiraling?

Debt service will likely swamp the entire federal budget.

Financial analyst Daniel Amerman:

If the interest rate on that debt were to rise by even 1%, the annual federal deficit rises by $200 billion. A 2% increase in interest rate levels would up the federal deficit by $400 billion, and if rates were 5% higher, the annual federal deficit rises by a full $1 trillion per year.

Recall, rates rocketed 6% or higher after two previous rate reversals.

Given the near-record intensity of the present rate depression cycle… should we not expect a similar rebound next time?

Hard logic dictates we should.

But what might bring down the curtain on the current cycle?

Unforeseen Catastrophe

Most previous rate depression cycles ended with death, destruction, howling, shrieking.

Examples, again, include the Black Plague, the Thirty Years War and World War II.

Perhaps a shock on their scale will close out the present cycle… for all that we know. Or perhaps some other cause entirely.

Of course, we can find no reason in law or equity why the second-longest, second-most intense rate depression cycle in history… cannot become the longest, most intense rate depression cycle in history.

The cycle could run years yet. Or it could end Friday morning.

The Lord only knows — and He is silent.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post 5,000 Years of Interest Rates, Part II appeared first on Daily Reckoning.

5,000 Years of Interest Rates, Part II

This post 5,000 Years of Interest Rates, Part II appeared first on Daily Reckoning.

Yesterday we hauled out evidence that interest rates have gone persistently down 500 years running.

And the high interest rates of the mid- to late 20th century?

These may be history’s true aberration, a violent but brief lurch in the chart… like a sudden burst of blood pressure.

Let us here reintroduce the graphic evidence:

IMG 1

Here is an extended picture of downward-trending rates — with the fabulous exception of the mid-to-late 20th century.

As Harvard economics professor Paul Schmelzing reckoned yesterday, as summarized by Willem H. Buiter in Project Syndicate:

Despite temporary stabilizations such as the periods 1550–1640, 1820–1850 or in fact 1950–1980… global… real rates have persistently trended downward over the past five centuries…

Can you therefore expect the downward journey of interest rates to proceed uninterrupted?

We have ransacked the historical data further still… rooted around for clues… and emerged with worrisome findings.

Why worrisome?

Details to follow. Let us first look in on another historical oddity, worrisome in its own way — the present stock market.

A Lull on Wall Street

It was an inconsequential day on Wall Street. The Dow Jones took a very slight slip, down nine points on the day.

The S&P scratched out a single-point gain; the Nasdaq gained 12 points today.

Gold and oil largely loafed, budging barely at all.

Meantime, humanity’s would-be saviors remained huddled at Davos. There they are setting the world to rights and deciding how we must live.

But let us resume our study of time… and money.

For light, we once again resort to the good Professor Schmelzing.

The arc of interest rates bends lower with time, he has established. But as he also establishes… no line bends true across five centuries of history.

Put aside the drastic mid-to-late 20th century reversal. Even the long downturning arc has its squiggles and twists, bent in the great forges of history.

To these we now turn…

“Real Rate Depression Cycles”

Over seven centuries, Schmelzing identifies nine “real rate depression cycles.”

These cycles feature a secular decline of real interest rates, followed by reversals — often sudden and violent reversals.

The first eight rate depression cycles tell fantastic tales…

They often pivoted upon high dramas like the Black Death of the mid-14th century… the Thirty Years’ War of the 17th century… and World War II.

IMG 2

The world is currently ensnared within history’s ninth rate depression cycle. This cycle began in the mid-1980s.

Schmelzing says one previous cycle comes closest to this, our own. That is the global “Long Depression” of the 1880s and ’90s.

This “Long Depression” witnessed “low productivity growth, deflationary price dynamics and the rise of global populism and protectionism.”

Need we draw the parallels to today?

It is here where our tale gathers pace… and acquires point.

A Thing of Historic Grandeur

Schmelzing’s research reveals this information:

This present cycle is a thing of historical grandeur, in both endurance and intensity.

Of the entire 700-year record… only one cycle had a greater endurance. That was in the 15th century.

And only one previous cycle — also from the same epoch — exceeded the current cycle’s intensity.

By almost any measure… today’s rate depression cycle is a thing for the ages.

Turn now to this chart. The steep downward slope on the right gives the flavor of its fevered intensity:

IMG 3

Schmelzing’s researches show the real rate for the entire 700-year history is 4.78%.

Meantime, the real rate for the past 200 years averages 2.6%.

Beware “Reversion to the Mean”

And so “relative to both historical benchmarks,” says this fellow, “the current market environment thus remains severely depressed.”

That is, real rates remain well beneath historical averages.

And if the term “reversion to the mean” has anything in it, the world is in for a hard jolt when the mean reverts. Why?

Because when rates do regain their bounce — history shows — they bounce high.

Schmelzing:

The evidence from eight previous “real rate depressions” is that turnarounds from such environments, when they occur, have typically been both quick and sizeable… Most reversals to “real rate stagnation” periods have been rapid, nonlinear and took place on average after 26 years.

Twenty-six years? The present rate depression cycle runs to 36 or 37 years. We must conclude it goes on loaned time. What happens when the loan comes due?:

Within 24 months after hitting their troughs in the rate depression cycle, rates gained on average 315 basis points [3.15%], with two reversals showing real rate appreciations of more than 600 basis points [6%] within two years.

The current rate depression cycle ranges far beyond average.

It is, after all, the second longest on record… and the second most intense.

If the magnitude of the bounceback approximates the magnitude of the cycle it ends… we can therefore expect a fantastic trampolining of rates.

That is, we can likely expect rate appreciations of 6% or more.

What Happens When Rates Rise?

The stock market and the decade-long economic “recovery” center upon ultra-low interest rates. And so we recoil, horrified, at the prospect of a “rapid, nonlinear” rate reversal.

We must next consider its impact on America’s ability to finance its hellacious debt…

A violent rate increase means debt service becomes an impossible burden.

How would America service its $23 trillion debt — a $23 trillion debt that jumps higher by the minute?

Debt service already represents the fastest-growing government expense.

Interest payments will total $460 billion this year, estimates the Congressional Budget Office (CBO).

CBO further projects debt service will scale $800 billion by decade’s end.

$800 billion exceeds today’s entire $738 billion defense budget. As it exceeds vastly present Medicare spending ($625 billion) and Medicaid spending ($412 billion).

CBO Doesn’t Account for Possible End to Rate Depression Cycle

But CBO pays no heed to the rate depression cycle. It — in fact — projects no substantial rate increases this decade.

But what if the present rate depression cycle closes… and interest rates go spiraling?

Debt service will likely swamp the entire federal budget.

Financial analyst Daniel Amerman:

If the interest rate on that debt were to rise by even 1%, the annual federal deficit rises by $200 billion. A 2% increase in interest rate levels would up the federal deficit by $400 billion, and if rates were 5% higher, the annual federal deficit rises by a full $1 trillion per year.

Recall, rates rocketed 6% or higher after two previous rate reversals.

Given the near-record intensity of the present rate depression cycle… should we not expect a similar rebound next time?

Hard logic dictates we should.

But what might bring down the curtain on the current cycle?

Unforeseen Catastrophe

Most previous rate depression cycles ended with death, destruction, howling, shrieking.

Examples, again, include the Black Plague, the Thirty Years War and World War II.

Perhaps a shock on their scale will close out the present cycle… for all that we know. Or perhaps some other cause entirely.

Of course, we can find no reason in law or equity why the second-longest, second-most intense rate depression cycle in history… cannot become the longest, most intense rate depression cycle in history.

The cycle could run years yet. Or it could end Friday morning.

The Lord only knows — and He is silent.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

The post 5,000 Years of Interest Rates, Part II appeared first on Daily Reckoning.

5,000 Years of Interest Rates

This post 5,000 Years of Interest Rates appeared first on Daily Reckoning.

“At no point in the history of the world has the interest on money been so low as it is now.”

Here the good Sen. Henry M. Teller of Colorado hits it square.

For 10 years plus, the Federal Reserve has waged a nearly ceaseless warfare upon interest rates.

Savers have staggered under the onslaughts. But the timeless laws of economics will not be forever put to rout.

We suspect they will one day prevail, and mightily. Interest rates will then revert to historical averages.

When they do, today’s crushing debt loads will come down in a heap. They will fall directly on the heads of governments and businesses alike.

This fear haunts our days… and poisons our nights.

Wait… What?

Let us check the date on the senator’s declaration…

Kind heaven, can it be?

Our agents inform us Sen. Teller’s statement entered the congressional minutes on Jan. 12… 1895.

1895 — some 19 years before the Federal Reserve drew its first ghoulish breath!

Were the late 19th century’s interest rates the lowest in world history?

Here at The Daily Reckoning, we are entertained infinitely by the dazzling present.

Its five-minute fads, its 15-minute fames, its popinjay actors strutting vainly across temporary stages…

All amuse us vastly and grandly.

They amuse us, that is — but they do not fascinate us.

It is the long view that draws us in — the view of the soaring eagle high overhead, the view from the mountaintop.

So today we rise above the daily churn, canvass history’s broad sweep… and report strange findings.

Quite possibly scandalous findings. Scandalous?

That is, we will investigate the theory that falling interest rates the historical norm… rather than the exception.

And are central banks powerless to direct them?

The Lowest Rates in 5,000 Years

The chart below gives 5,000 years of interest rate history. It shows the justice in Sen. Teller’s argument.

Direct your attention to anno Domini 1895. Rates had never been lower. Not in all of recorded history:

IMG 1

Rates would sink lower only on two subsequent occasions — the dark, depressed days of the early 1930s — and the present day, dark and depressed in its own way.

The Arc of the Universe Bends Toward Low Interest Rates

Paul Schmelzing professes economics at Harvard. He is also a visiting scholar at the Bank of England. And he has conducted a strict inquiry into interest rates throughout history.

Many take the soaring interest rates of the later 20th century as their guide, he begins:

The discussion of longer-term trends in real rates is often confined to the second half of the 20th century, identifying the high inflation period of the 1970s and early 1980s as an inflection point triggering a multidecade fall in real rates. And indeed, in most economists’ eyes, considering interest rate dynamics over the 20th century horizon — or even over the last 150 years — the reversal during the last quarter of the 1900s at first appears decisive…

Here the good professor refers to “real rates.”

The real interest rate is the nominal rate minus inflation. Thus it penetrates the monetary illusion. It exposes inflation’s false tricks — and the frauds who put them out.

In one word… it clarifies.

And the chart reveals another capital fact…

The Long View

Revisit the chart above. Now take an eraser in hand. Run it across the violent lurch of the mid-to-late 20th century. You will then come upon this arresting discovery:

Long-term interest rates have trended downward five centuries running. It is this, the long view, that Schmelzing takes:

Despite temporary stabilizations such as the period between 1550–1640, 1820–1850 or in fact 1950–1980 global real rates have shown a persistent downward trend over the past five centuries…

This downward trend has persisted throughout the historical gold, silver, mixed bullion and fiat monetary regimes… and long preceded the emergence of modern central banks.

What is more, today’s low rates represent a mere “catch-up period” to historical trends:

This suggests that deeply entrenched trends are at work — the recent years are a mere “catch-up period”…

In this sense, the decline of real returns across a variety of different asset classes since the 1980s in fact represents merely a return to long-term historical trends. All of this suggests that the “secular stagnation” narrative, to the extent that it posits an aberration of longer-term dynamics over recent decades, appears fully misleading.

Is it true? Is the nearly vertical interest rate regime of the mid-to late 20th century a historical one-off… a chance peak rising sheer from an endless downslope?

What explains it?

Interest Rate Spikes, Explained

Galloping economic growth explains it, says analyst Lance Roberts of Real Inves‌tment Advice.

He argues that periods of sharply rising interest rates are history’s lovely exceptions.

Why lovely?

Interest rates are a function of strong, organic, economic growth that leads to a rising demand for capital over time.

In this view, rates soared at the dawn of the 20th century. It was, after all, a time of rapid industrialization and dizzying technological advance.

Likewise, the massive post-World War II rate spike owes directly to the economic expansion then taking wing. Roberts:

There have been two previous periods in history that have had the necessary ingredients to support rising interest rates. The first was during the turn of the previous century as the country became more accessible via railroads and automobiles, production ramped up for World War I and America began the shift from an agricultural to industrial economy.

The second period occurred post-World War II as America became the “last man standing”… It was here that America found its strongest run of economic growth in its history as the “boys of war” returned home to start rebuilding the countries that they had just destroyed.

Let the record show that rates peaked in 1981. Let it further show that rates have declined steadily ever since.

And so we wonder…

Was the post-World War II period of dramatic and exceptional growth… itself the exception?

The Return to Normal

Let us widen our investigation by summoning additional observers. For example, New York Times senior economic correspondent Neil Irwin:

Investors have often talked about the global economy since the crisis as reflecting a “new normal” of slow growth and low inflation. But just maybe, we have really returned to the old normal.

More:

Very low rates have often persisted for decades upon decades, pretty much whenever inflation is quiescent, as it is now… The real aberration looks like the 7.3% average experienced in the United States from 1970–2007.

That is precisely the case Schmelzing argues.

Now consider the testimony of a certain Bryan Taylor. He is chief economist at Global Financial Data:

“We’re returning to normal, and it’s just taken time for people to realize that.”

Just so. We must nonetheless file a vigorous caveat…

A Pursuit of the Wind

Drawing true connections between historical eras can be a snare, a chasing after geese, a pursuit of the wind.

Success requires a sharpshooter’s eye… a surgeon’s hand… and an owl’s wisdom.

The aforesaid Schmelzing knew the risks before setting out. But he believes he has emerged from the maze, clutching the elusive grail of truth.

Today’s low rates are not the exceptions, he concludes in reminder. They represent a course correction, a return to the long, proper path.

How long will this downward trend continue, professor Schmelzing?

The Look Ahead

Whatever the precise dominant driver — simply extrapolating such long-term historical trends suggests that negative real rates will not just soon constitute a “new normal” — they will continue to fall constantly. By the late 2020s, global short-term real rates will have reached permanently negative territory. By the second half of this century, global long-term real rates will have followed…

But can the Federal Reserve throw its false weights upon the scales… and send rates tipping the other way?

With regards to policy, very low real rates can be expected to become a permanent and protracted monetary policy problem…

The long-term historical data suggests that, whatever the ultimate driver, or combination of drivers, the forces responsible have been indifferent to monetary or political regimes; they have kept exercising their pull on interest rate levels irrespective of the existence of central banks… or permanently higher public expenditures. They persisted in what amounted to early modern patrician plutocracies, as well as in modern democratic environments…

We have argued previously that central banks wield far less influence than commonly supposed. Here we are validated.

But we are unconvinced rates are headed inexorably and unerringly down.

Tomorrow, another possible lesson — a warning — from the book of interest rates.

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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A World Gone Mad

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Today we gasp, stagger, reel.

The enormity of it all has finally overmatched our capacities. Consider…

Total global debt presently piles up to 322% of GDP — a record.

Total “developed world” debt piles higher yet — 383% of GDP — another record.

The world’s stock markets combine to $88 trillion, or 100% of global GDP. That is another record yet.

Record upon record upon record has come down… as debt has gone relentlessly up.

And what does the world have to show for the deluge?

Little Bang for the Buck

Real United States GDP growth gutters along under 2%. Fair estimates place European and Japanese 2020 growth under 1%.

Interest rates, meantime, are coming down. And so the supply of “dry powder” available to the central banks is coming down. They will require heaps of it come the next crisis.

Project Syndicate, in summary:

The major developed economies are not only flirting with overvalued financial markets and still relying on a failed monetary-policy strategy, but they are also lacking a growth cushion just when they may need it most.

Direct your attention now to the Bank of England. Specifically, to its balance sheet…

Where’s the Crisis?

As a percentage of GDP…

Not once in three centuries has this balance sheet swollen to today’s preposterous extreme…

Not when England was life and death with Napoleon, not when England was life and death with the kaiser, not when England was life and death with Hitler:

IMG 1

The Bank of England’s balance sheet — again, as a percentage of GDP — presently nears 30%.

It never cleared 20% even when England was absorbing obscene debts to put down Herr Hitler.

Where is today’s Napoleon? Where is today’s kaiser? Indeed… where is today’s Hitler?

Yet the balance sheet indicates England is battling the three at once. And on 1,000 fronts the world across.

We razz our English cousins only because the Bank of England is nearly the oldest central bank going (est.1694) and keeps exquisite records.

It therefore offers a detailed, three-century sketch of central banking’s shifting moods.

Our own Federal Reserve’s history stretches only to 1913. But its compressed history offers a parallel example…

Crisis-Level Balance Sheet

Its balance sheet expanded to perhaps 20% of GDP against the twin calamities of the Great Depression and Second World War.

It then came steadily, inexorably and appropriately down, decade after decade. Pre-financial crisis… that percentage dropped to a stunning 6%.

But then the great quake of ’08 rumbled on through… and shook the walls of Jericho to their very foundations.

The Federal Reserve got out its mason kits and set to patching the damage.

Patching the damage? It built the walls up higher than ever…

By 2014 quantitative easing and the rest of it swelled the balance sheet to 25% of GDP. That, recall, is five full percentage points above its 20th-century crisis peaks.

Mr. Powell’s subsequent quantitative tightening knocked down some of the recent construction.

The balance sheet — as a percentage of GDP — slipped beneath 20% by 2018.

But last year he pulled back the sledgehammers. Then, in September, the short-term money markets began giving out… and Powell rushed in with the supports.

The Fastest Expansion Ever

He has since expanded the balance sheet some $400 billion in a four-month span — over 10%. Not even the financial crisis saw such a violent expansion.

As we have presented before, the visual evidence:

IMG 2

The balance sheet presently nears $4.2 trillion, only slightly beneath its 2015 maximum.

Here then is irony…

“A Magnet for Trouble”

Observe the 2012–14 comments of Carlyle Group partner Jerome Powell — before he was Federal Reserve chairman Jerome Powell:

I have concerns about more purchases. As others have pointed out, the dealer community is now assuming close to a $4 trillion balance sheet and purchases through the first quarter of 2014. I admit that is a much stronger reaction than I anticipated, and I am uncomfortable with it for a couple of reasons.

First, the question, why stop at $4 trillion? The market in most cases will cheer us for doing more. It will never be enough for the market. Our models will always tell us that we are helping the economy, and I will probably always feel that those benefits are overestimated…. What is to stop us, other than much faster economic growth, which it is probably not in our power to produce?…

[W]hen it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response…

Continues the present chairman:

My [next] concern… is the problem of exiting from a near $4 trillion balance sheet… It just seems to me that we seem to be way too confident that exit can be managed smoothly. Markets can be much more dynamic than we appear to think…

I think we are actually at a point of encouraging risk-taking, and that should give us pause…

I kind of think that a large balance sheet might prove to be a magnet for trouble over time… So I tentatively land on a floor system with the smallest possible balance sheet…

“Why stop at $4 trillion?”… “It will never be enough for the market”… “faster economic growth, which it is probably not in our power to produce”… “a large balance sheet might prove to be a magnet for trouble over time”… “I tentatively land on a floor system with the smallest possible balance sheet”…

Again — here is irony.

What Happened to Powell?

Where a fellow stands often depends upon where he sits. And this particular fellow sits in the chairman’s seat at the Federal Reserve.

The Federal Reserve has a certain institutional… perspective.

And so he leans whichever way it slants.

Our co-founder Bill Bonner puts it this way:

“People come to believe whatever they must believe when they must believe it.”

What does Mr. Powell’s 2012–14 self, the conscience tapping naggingly on his shoulder, tell him?

That no enormity is ever enough for the market? Something about a magnet for trouble? A preference for the smallest possible balance sheet perhaps?

But Jerome Powell has come to believe what he must… when he needed to believe it.

We shudder at what he will come to believe come the crisis — or whatever his successor will come to believe.

Meantime, the world runs to record debt, its stock markets run to record highs…

And we are about ready to run for the hills…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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The Fed Gets Blindsided… Again

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The big news this week was that the House of Representatives impeached President Trump for abuse of power and obstruction of Congress.

Trump now joins Andrew Johnson and Bill Clinton as the only U.S. presidents to be impeached (Nixon resigned before he could be impeached).

Now it goes to the Senate for trial. But there’s virtually no chance the Senate will convict Trump on the charges, given the Republican majority.

The market has completely shrugged off the news. The stock market is up today, which tells you it doesn’t fear political instability or expect anything to come of the impeachment process.

But the real market story right now on Wall Street has to do with the Fed, and it’s not getting anywhere near the attention it deserves.

Since September, the Fed’s been pumping in massive amounts of liquidity into the “repo” markets to keep the machinery of the financial system lubricated.

So far, the figure stands at about $400 billion. But it’s showing no signs of slowing down.

The Fed has now announced it will provide an additional $425 billion of cash injections into the repo market as the year draws to a close on concerns that funding could fall short into year’s end.

And Jerome Powell has admitted these injections will continue “at least into the second quarter” of 2020.

What does all this bailout money say about the health of the money markets?

And that’s really what it is — a bailout. Without Fed intervention, liquidity in these markets would have dried up.

But the Fed’s massive liquidity injections are basically a Band-Aid on the real problem.

There’s plenty of liquidity in the market right now. The real problem is that the big banks, the 24 “primary dealers” who have direct access to the Fed’s liquidity, aren’t lending the money out like they’re supposed to.

They’re sitting on it, which is depriving other banks and financial institutions of the short-term funding they need.

Part of it has to do with regulations that require these banks to hold a certain amount of reserves, so they’re reluctant to lend them.

But it’s also because these banks can earn more on their money by parking their reserves at the Fed than they can lending it out, which pays very little interest.

Here’s what one portfolio manager, Bryce Doty, says about it:

The big banks are just hoarding cash. They told the Fed they have more than enough cash in excess reserves to meet regulatory issues, but they prefer having money at the Fed where they can still earn 1.55%, rather than in the repo market.

So, until that situation changes, there’s no reason to expect that the Fed’s support will go away anytime soon.

But if you ask New York Fed head John Williams, everything’s just hunky-dory.

He says it’s all “working really well.” But the Fed is having to expand its balance sheet at the fastest pace since the first round of QE began in December 2008.

It’s gone from $3.8 trillion in September to over $4.07 trillion today. And it’s going higher.

Would all this be necessary if the system were working well?

The Federal Reserve’s Board of Governors recently published its annual Supervision and Regulation Report, which measures the financial condition of major U.S. banks, including loan growth and liquidity in the banking system.

How did the banks grade?

Overall, the board concluded that 45% of U.S. banks with more than $100 billion in assets merited a rating of “less than satisfactory.”

Tellingly, the report did not say which banks have these less-than-satisfactory ratings. It doesn’t want to make any real waves, after all. The entire system depends on confidence.

Of course, the Fed didn’t see problems in the repo market coming at all. They never do. All they ever do is react and pretend that they have everything under control.

Basically, the Fed was blindsided… Again.

But they don’t have everything under control or they would have seen the problems coming and maybe done something about it.

Continued problems in the repo market may mean the Fed could launch another round of official quantitative easing in the very near future, possibly as soon as early January.

The good news for the markets is that the Fed’s liquidity injections have helped boost stocks to record levels again.

The Fed is basically handing investors a Christmas present. Unfortunately, most people on Main Street don’t realize it. The present’s being put under the tree this year (and maybe next) won’t last. They can’t.

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The Fed Is Toying With Fire

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Deutsche Bank maintains a strict dossier on all the world’s asset classes.

Stocks, bonds, real estate, commodities — 38 assets, A through Z — Deutsche Bank has them under ruthless and unshakable surveillance.

Last December’s spywork revealed this arresting conclusion:

93% of all the world’s assets traded negative in 2018.

Not even in the fathomless depths of the Great Depression did so many global assets wallow in red.

But last year is last year. Scroll the calendar one year forward… to today.

What do we find?

We find a full 180-degree turning around.

Each and every asset Deutsche Bank tracks — all 38 — trade positive this year.

Affirms Deutsche Bank’s Craig Nicol:

All 38 assets in its tracking universe have posted positive year-to-date (YTD) returns in both local currency and dollar terms.

To what earthly energy can we ascribe this complete and dramatic reversal?

The answer — the truly shocking answer — in one moment.

We first consider a more immediate reversal…

Trump Sends Stocks Reeling

The Dow Jones went badly backwards this morning, down 400 points. It came back a bit in the afternoon, losing only 280 points by closing whistle.

The S&P and Nasdaq followed parallel routes.

The S&P lost 20 points on the day. The Nasdaq lost 47.

The negative catalyst came issuing out of 1600 Pennsylvania Ave. this morning…

Mr. Trump announced that a trade accord can wait. Wait until when?

Until after the 2020 election is concluded:

In some ways, I like the idea of waiting until after the election for the China deal, but they want to make a deal now and we will see whether or not the deal is going to be right… I have no deadline… In some ways, I think it is better to wait until after the election if you want to know the truth.

Wall Street’s trading algorithms plucked the news off the wires… and began to sweat.

Trade-sensitive stocks such as Apple and Caterpillar endured the greatest trouncings today, unsurprisingly.

Equally unsurprisingly, safe haven gold jumped $14 on the day.

And so the merry-go-round takes another spin. Which direction tomorrow takes it… who can say?

But to return to our central question:

Why are all 38 assets Deutsche Bank tracks positive on the year — when 93% of these same assets were negative last year?

Too Obvious for Words

We claimed above that the answer was “truly shocking.” But we merely perpetrated a con to hold your attention.

The answer is obvious to anyone with eyes willing and able to see…

The Federal Reserve was increasing interest rates and trimming its balance sheet in 2018. Last December Jerome Powell announced the business would proceed uninterrupted.

That was when the stock market fell into open and general revolt.

By Christmas Eve… it was a whisker away from “correction.”

And so Jerome Powell dropped his weapons, hoisted his surrender flag… and came out hands in the air.

Wall Street had him.

Safely under lock, safely under key… Powell proceeded to lower rates three instances this year.

What is more, he called a premature halt to the quantitative tightening he had previously declared on “autopilot.”

Who can then be surprised that the Dow Jones industrial average has advanced 4,000 points this year?

Or that the other major indexes have marched with it?

But our tale does not conclude here. Instead, it takes a meandering twist down a side road…

A November to Remember

Rate cuts only partially explain this year’s asset extravaganza. The termination of quantitative tightening only partially explains this year’s asset extravaganza.

Can we credit a general optimism on trade (despite this morning’s blood and thunder)?

Perhaps partially — but only partially.

Whatever trade gives, trade takes back.

The promised trade deal has proved an endless frustration, a pretty plum dangled always beyond reach, a Christmas morning put off again, again and again.

For a full and complete explanation of the year in assets… we must peer deep within Deutsche Bank’s report.

There we will find this chestnut sandwiched within:

November posted some of the year’s loveliest asset gains. November, that is, hoisted all boats on its rising tide.

Why November?

For the answer we must first revisit September… and the “repo” market.

Just Don’t Call It QE4

Overnight lending rates leapt to 10% as liquidity ran dry — a high multiple of the federal funds rate then prevailing.

The Federal Reserve instantly hosed in emergency liquids to suppress the insurrection.

Mr. Powell declared the operation “temporary.” But on and on it went — into October, into November (and into December).

By November Mr. Powell and his minions at the New York Federal Reserve emptied in some $280 billion of liquidy credit.

They shrieked, howled and fumed that these “open market operations” were in no way quantitative easing.

Yet these activities inflated the Federal Reserve’s balance sheet… precisely as if they were quantitative easing itself.

From its maximum $4.5 trillion enormity, the quantitative tightening of 2018–19 siphoned down the balance sheet to $3.8 trillion.

But along came September… and its temporary open market operations.

By mid-November they reinflated the balance sheet to $4.04 trillion. Let us reintroduce the evidence we initially entered into record Nov. 15:

IMG 1

Smoking-gun Evidence

In all, the Federal Reserve has inflated the balance sheet $293 billion in under three months.

When was the last occasion the Federal Reserve carried on with such frantic fanaticism?

October 2008 — in the wildest psychosis of the financial crisis.

If you seek a thorough explanation for November’s asset surge, here you are.

But perhaps you demand further evidence. Then further evidence you shall have.

Here is the pistol, smoke oozing from its barrel…

The S&P turned in only one negative week these past two months. That was the same week — and the only week — that the balance sheet contracted.

Mainstream displays of lucidity and insight are rare and shocking. But here you have one, by way of CNBC’s Carl Quintanilla.

Dated Nov. 18:

Whether it should be considered QE4 or not, in the eyes of the market it’s just semantics. Markets view any increase in the size of the Fed’s balance sheet as QE and the $250 billion increase in just two months is no doubt helping to lift stock prices.

And the cup runneth over…

Hence November’s outsized influence on assets in general.

Hence we find all 38 asset classes Deutsche Bank tracks positive on the year.

But here is the danger:

The Federal Reserve’s liquidity may be kerosene that ultimately fans a conflagration…

A Potential Inferno

In Bank of America’s telling, Fed support of repo markets raises systemic financial risk.

That is because it allows excess leverage to pile up. If it comes tumbling down, if the system deleverages… it may strike the match on one royal blaze.

Bank of America’s Ralph Axel:

… there may be a situation in which banks want to deleverage quickly, for example during a money run or a liquidation in some market caused by a sudden reassessment of value as in 2008… the Fed’s abundant-reserve regime may carry a new set of risks by supporting… overly easy policy (expanding balance sheet during an economic expansion) to maintain funding conditions that may short-circuit the market’s ability to accurately price the supply and demand for leverage as asset prices rise.

Meantime, the Federal Reserve pours forth an average $5 billion of flammable liquid each day.

And someone, somewhere, is holding a match…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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Why Powell Might NOT Cut Rates

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The market’s been bouncing around lately, anxiously waiting to see it the Fed cuts interest rates next week. All indications now suggest that it will. The question is by how much?

Minutes from June’s Federal Open Market Committee (FOMC) meeting that were released earlier this month indicated support for a rate cut. Certain committee officials noted that as long as uncertainty still weighed on its outlook, they would be willing to cut rates.

And during his much-awaited biannual testimony before the House Financial Services Committee, Federal Reserve Chairman Jerome Powell hinted — strongly — that a rate cut was around the corner.

Powell told the committee, “It appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook. Inflation pressures remain muted.”

But the subsequent release of better-than-expected June employment figures complicated the matter of rate cut size and timing.

They raised the possibility that those positive jobs numbers would keep the Fed from cutting rates. After all, it doesn’t make a lot of sense to cut interest rates when the job market is so hot and unemployment is at 50-year lows.

But despite that concern, markets are still placing the odds of a rate cut of 25 basis points at 100%, with lower expectations for a 50 basis point cut.

This means a rate cut is already “baked into the cake.” However, the risk is that if Jerome Powell and the FOMC don’t cut rates next week, it could cause a sharp sell-off.

We’ll have our answer next week. But despite the overwhelming market expectations for a rate cut, I think there’s a chance the Fed won’t cut rates yet. That’s because Powell may still want to signal the Fed’s ability to act independently from White House pressure.

I realize that puts me in the extreme minority. But that’s OK, it certainly isn’t the first time.

But there’s something else going on right now that could trip up markets.

Earnings season is underway. Over the next few weeks, all of the S&P 500 companies will be rolling out their earnings figures. And more than a quarter of them will report earnings this week.

Firms from Google’s parent company, Alphabet, to Amazon, McDonald’s and Boeing are among the more than 130 companies that are reporting.

Even with a rate cut, poor corporate earnings could spell trouble for stocks. The trade war would be partly responsible. Certainly, there remains no resolution on the U.S.-China trade war front. And the trade war combined with slowing growth could amplify the effects of weak earnings.

As one article reports, “Stocks could struggle if the earnings message from corporate America focuses on the murky outlook for the economy and negative impacts from the trade wars.”

Earnings so far have been positive, but that can be misleading. That’s because second-quarter earnings expectations were kept low so that corporations could easily beat them.

Their actual earnings may not be underwhelming. But if they beat expectations, that’s all that counts.

And as I learned on Wall Street, corporations often talk down their earnings estimates in order to set a low bar. That way they can easily beat the forecast, which produces a jump in the stock price.

As Ed Keon, chief investment strategist at QMA explains:

No matter what the economic circumstances are, no matter what the backdrop is, there’s this dynamic that companies like to lowball and analysts like to give them headroom. The fact that numbers are coming in better than expected — it’s been the case for decades now.

Of the 114 companies that provided second-quarter guidance as of last week, 77% released negative forecasts, according to FactSet.

But it’s still early and there’s a long way to go.

Most industrial companies haven’t reported earnings yet. And they could reveal extensive damage from the trade war. As CFRA investment strategist Lindsey Bell says:

As we get more industrials in the next couple of weeks, I think that will create more volatility and drive the market lower in the near term… Chemicals and metals are two areas where I expect pressure.

We’ll see. But if markets do stumble, you can expect the Fed will be ready to cut rates at its meeting in September. That means more “dark money” will be coming to support markets, even if the Fed doesn’t cut rates next week.

And that’ll keep the bull market going for a while longer. One day the music will end. The imbalances in the system are just too great.

But we’re not at that point yet, and you can expect markets to rise on additional dark money injections.

Enjoy it while you can.

Below, I show you one major factor that will continue to support stocks this year. It doesn’t have to do with the trade war or earnings. What is it? Read on.

Regards,

Nomi Prins
for The Daily Reckoning

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Jerome Powell Caves

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Jerome Powell chummed the seawater this morning. And the voracious sharks rose to the bait… 

In written testimony to Congress, Mr. Powell informed us that:

Crosscurrents have reemerged. Many FOMC participants saw that the case for a somewhat more accommodative monetary policy had strengthened. Since [the Fed meeting in June], based on incoming data and other developments, it appears that uncertainties around trade tensions and concerns about the strength of the global economy continue to weigh on the U.S. economic outlook… Growth indicators from around the world have disappointed on net, raising concerns that weakness in the global economy will continue to affect the U.S. economy.

What is more… he re-babbled his oath that the Federal Reserve would “act as appropriate to sustain the expansion.” 

Translated into good hard English: Expect a rate cut later this month.

Affirms Bloomberg Federal Reserve-ologist Steve Matthews: 

“Powell didn’t say so explicitly, but it’s hard to read this other than he thinks a cut in July would be appropriate.”

Powell’s dispatch, adds Peter Boockvar of Bleakley Advisory Group…

“…fully endorsed the July rate cut and did absolutely nothing to pull the markets back from that expectation.” 

The stock market was up and away on the news…

The S&P Tops 3,000 For The First Time In History 

For the first occasion in its 62 years… the S&P poked its head above the 3,000 mark this morning.

The Nasdaq registered a fresh record of its own. And the Dow Jones bounded nearly 200 points.

But the opening frenzy squandered much of the day’s energy… and the averages gradually lost their steam.

The Dow Jones ended the day up 75 points, at 26,859. 

After catching its first glimpse of 3,000, the S&P dipped back down to 2,992. The Nasdaq, meantime, closed the day with a 61- point gain. 

And so it goes…

100% Chance Of A July Rate Cut

Federal funds futures — incidentally — now give 100% odds of a rate cut later this month.

But what about the rest of the year… and next year? To what inky depths will the Federal Reserve lower rates?

Perhaps even lower than markets expect — if you take history as your teacher.

Markets presently expect Mr. Powell and his goons to cut rates 75 basis points by January.

Seventy-five basis points imply three rate cuts (a typical rate cut — or hike — is 25 basis points).

Three rate cuts by year’s end are plenty heady.

But according to Michael Lebowitz of Real Investment Advice, history argues even stronger drink is in prospect…

Markets Underestimate How Far Rates Could Sink

If the Federal Reserve undertakes a hike cycle, he maintains, it often elevates rates higher than markets project.

And when the Federal Reserve begins cutting rates… it hatchets them even lower than markets expect.

Lebowitz:

Looking at the 2004–06 rate hike cycle… the market consistently underestimated the pace of fed funds rate increases…

During the 2007–09 rate cut cycle, the market consistently thought fed funds rates would be higher than what truly prevailed…

The market has underestimated the Fed’s intent to raise and lower rates every single time they changed the course of monetary policy meaningfully.

Lebowitz says markets have underestimated rate cut intensity for the previous three cycles.

And Mr. Powell currently has his hatchet out.

In conclusion:

If the Fed initiates rate cuts and if the data… prove prescient, then current estimates for a fed funds rate of 1.50 –1.75% in the spring of 2020 may be well above what we ultimately see. 

And here Lebowitz seizes us by the shoulders… and gives us a good hard shaking:

Taking it a step further, it is not far-fetched to think that that fed funds rate could be back at the zero-bound or even negative at some point sooner than anyone can fathom today.

Who could? Fathom it, that is.

Just last year the monetary authorities gloated about “globally synchronized growth” and their march back to “normalcy.” 

Now they are preparing to about-face… and go scurrying back to zero? 

Who can take these gentlemen and ladies seriously?

The Fed Can Never Normalize Interest Rates

Here is our guess: Once they turn around, they will never come back. 

The Federal Reserve cannot return to normal. 

Returning to normal would knock the economy flat. And the stock market would come down in a thundering heap.

Only low interest rates keep it all vertical.

But as we have noted repeatedly… watch out for the next rate cut.

The past three recessions each commenced within three months of the first rate cut that ended a hiking cycle.

We find no reason to believe “this time will be different.”

The next rate cut — likely this month — starts the clock ticking.

We could be wrong of course. 

The inscrutable gods keep their own schedule. Who knows how long the show might run?

Out of Ammunition

But come the inevitable recession…

The Federal Reserve will have very little ammunition to hurl against it.

And the closer it gets to zero, the less ammunition it will hold.

History says it requires interest rates of at least 4% to wage a successful battle.

Rates are presently between 2.25% and 2.50%.

They are about to sink lower. Perhaps drastically lower. 

That is, the Federal Reserve is badly outgunned as it presently stands.

If the economy somehow pegs along until rates are zero — or near zero — the Federal Reserve would be on its knees… defenseless.

It will have another desperate go at quantitative easing. But multiple rounds did little (nothing) to raise the economy last time.

Why would it work next time?

The Next Crackpot Cure

That is why we expect the next anti-recession cure — disaster, that is — will not be monetary.

It will be fiscal.

The cries will go out…

“QE for Wall Street did nothing for the economy. The time for QE for Main Street has come.” 

The authorities will take to their helicopters, hover over Main… and begin shoveling money out the side.

The throngs below will haul it all in. They will proceed to go spreeing through the stores. The resulting delirium will give the economy a wild jolt.

That is the theory… as far as it runs.

It in part explains the loudening shouts for Modern Monetary Theory (MMT).  

Its drummers claim it can invigorate the wilting American economy.

They further claim it can fund ambitious social programs — all without raids upon the taxpayer.

And if interest rates are shackled down, without blasting the deficit.

The printing press will supply the money.

But as we have argued prior, MMT is the eternal quest for the free lunch… water into wine… something for nothing.

And that world has no existence.

MMT would likely yield a gorgeous inflation. But the economic growth it promises… would be a promise broken.

It will join the broken promise of monetary policy…

Regards,

Brian Maher
Managing editor, The Daily Reckoning

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