Hey There Income Hunters,
I called Jerome “J-Pow” Powell the Rodney Dangerfield of Economists earlier in the week.
He is certainly living up to that reputation.
During testimony before the Senate Banking Committee on Thursday …
- Powell made it clear that inflation is running much hotter than the Fed thought it would be — and for longer.
- When asked what tools the Fed has to curb inflation, he said … to raise interest rates and take money out of the economy.
What happened to his comments earlier in the week that underscored inflation is transitory and that he expected it to moderate?
Treasury Secretary Janet Yellen joined Powell in the flip-flop, chiming in through the media and saying her agency wants to make sure inflation remains under control
This after she has been singing the same transitory tune as Powell!
But this is par for the course for Fed-led efforts throughout history.
And it clearly shows our central bank is again grasping for ideas.
That creates uncertainty in the markets and choppiness that makes it hard to trade in the short term but really has no impact on the larger trend.
Let’s consider two of the Fed’s many mistakes from the past so we can understand what may occur in the short run, while reiterating what the focus is for the long term …
Two massive mistakes by the Fed in the Past
1. In 1936, as the economy was still recovering from the 1929 crash, the Fed started raising rates, which pushed the economy back into recession.
The economy remained strong going into early 1937. The stock market was still rising, industrial production remained healthy and inflation picked up to around 5%.
In response, the Fed raised rates three times in the first half of the year. The tighter money and reduced liquidity led to a sell off in bonds and a rise in the short rate.
The Treasury Secretary at the time, Henry Morgenthau, was furious and argued that the Fed should offset the “panic” through open market operations to make net purchases of bonds.
Morgenthau ordered the Treasury into the market to purchase bonds itself …
Fed Chairman Marriner Eccles pushed back, urging the Treasury to balance the budget and raise tax rates to begin to retire debt, which were really stupid thoughts.
Check out the reaction in the stock market from this approach — a 60% downturn in stocks in 1937.
2. In 2017, the economy was growing — albeit very slowly 00 after the greatest bailout and money printing spree in history…
Following the 2008 financial crisis, the growth in the economy was underwhelming.
After all the money printing (quantitative easing), the economy barely grew above 2%.
Still, full employment was reached, and inflation went above the 2% target…
The economy remained fragile and many people were out of work — just not looking for jobs.
The Fed pushed forward with tapering and raising rates, raising them 2016, they raised them from .5% to 2.5% between 2016 and December 2018.
There were signs that credit conditions were tight in the repo market, but Powell went ahead with more tightening in 2018.
Here’s how that went …
Takeaways from the Two Events
- Notice who the first drop in the market was met with strong buying and either got close to or took out the previous high. The second drop was the big one.
- The initial drops were roughly 13% drops.
Both events show the Fed wasn’t aware of the fragility in the market coming off such a serious shock.
I think the Fed may be heading towards a much bigger mistake today …
Raising interest rates now based on inflation could cause massive debt defaults as higher rates could push businesses into insolvency.
In effect, we could turn into a zombie economy similar to Japan — where many businesses can only survive with ongoing assistance.
Bring it Home
Let’s hope the Fed and our government leaders look back and learn a lesson about the damaging effects of raising rates when a potential $28 billion debt crisis is brewing.
The Fed’s flip-flop approach to the markets is inexcusable, but the only thing investors can do is focus on the longer-term picture of knowing what happens at the end of a long-term debt cycle…
The currency and bonds are devalued — leading to a very negative effect on the stock indices.
Option strategies that pay for themselves by getting you long decay (theta) can protect your downside until the dollar breaks down and triggers the renewed uptrend in commodities and metals.
Check out the replay of Thursday’s event, which provides some awesome trade ideas and where I clearly show inflation’s impact on financial assets.
Live and Trade With Passion My Friends,