When the Fed Pivots, It Will be Time to Re-focus on Equities
The market will likely only begin to form a bottom and interest rates will stop going up when the Fed pivot’s from it’s current trajectory.
So, when will the Fed pivot?
Federal Reserve Chair Jerome Powell is telling you, when inflation hits his target of 2%. As you can see below, we are not there yet, and in fact, the last print of Core CPI was up. To be clear, we are not close, YET, and Core CPI may not be the reason why the Fed pivots.
An excellent article written by hedge fund manager Harris Kupperman, founder of Praetorian Capital, made many brilliant points that we certainly agree with. Kupperman says our government has run obscene deficits over the past two decades due to suppressing interest rates. Despite a success of Treasury Secretaries, the US debt was never termed out. The following are other key points:
- The Fed is trapped in a box of their OWN CREATION.
- The Fed claims that they are targeting a terminal rate of 4.6% for Fed Funds, but if they did that for any period, they’d only succeed in blowing up the Treasury.
- During 2021, the Federal government paid $392 billion in interest on $21.7 trillion of average debt outstanding-or an average interest rate of 1.8%.
- What would paying an average rate of 4.6% on year-end 2021 debt do to the interest expense? It rises by $636 billion to $1.028 trillion. This is more than the cost of our entire military spending of $801 billion in 2021.
- Our deficits have historically been funded by the Federal Reserve purchasing government bonds through their Quantitative Easing or QE program, however, this program is now going in reverse, which is called Quantitative Tightening or QT. Instead of the Fed buying treasuries, they are now selling to remove them off their balance sheet.
- KEY POINT: If they’re selling bonds while the Treasury needs to accelerate their own debt issuances to cover the increased cost of interest, as just explained in point number four, then rates will be forced higher-potentially much higher.
- KEY POINT TWO: As rates go higher, government interest costs will increase, and the cycle will accelerate the cash drain from the Treasury.
This can be completely disastrous for our country, because historically, this has led to complete crisis’ like we have seen in Emerging Countries, more recently, Japan and UK. The Fed wants to control inflation, like Paul Volcker did in the 80’s, however, he runs the risk of blowing up the treasury, and that is not a risk they want to take. In addition, if the interest costs go up for the Federal Government, and you add a recession on top of that where the US Government will receive less tax receipts, that is a double whammy.
I started by saying, “When the Fed Pivots, the market will bottom”. Well, as the above begins to unfold, politics will force Powell to back down and he will have to pivot. They will decide that increased inflation is preferable to detonating the treasury.
From an investment standpoint, therefore long-term investors should stay disciplined with their approach. This has certainly been a challenging year, and things can get worse, but when the tide turns, it will be quick.
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