Why the Fed doesn’t want to take rates negative… and why it can’t let rates climb too much… what this means for asset prices… how Louis Navellier is approaching this market
The Fed is walking a tight rope when it comes to its interest rate policy.
But as we’ll see today, walking this tight rope is leading only to one destination – climbing asset prices.
There’s a lot to unpack here, so let’s back up to fill in the details…
The Fed Funds target rate currently sits at 0% – 0.25%. In other words, any additional move south would mean officially taking rates negative.
The Fed says it doesn’t want this.
From Yahoo! Finance:
But Fed officials, who managed to avoid (taking rates negative) through an economic shutdown of unprecedented scale, have made it clear that negative interest rates are low on their lists of preferred policy tools.
“Negative rates I think have a worse cost-benefit relationship than the other tools that we have,” New York Fed President John Williams told reporters on Monday morning…
An October 2019 discussion of negative rates noted that all of the Fed’s policy-setting members disliked the idea of implementing the policy in the U.S.
“The committee’s view on negative rates really has not changed. This is not something we’re looking at,” Powell said in May 2020.
Plus, even though we’ve seen negative rates in Europe without a complete fiscal meltdown (though not without issues), negative rates in the U.S. would be more problematic.
The U.S. has a $4.5 trillion money market that is heavily reliant on short-term rates. This is too large, and it’s too interconnected to public and private sectors, to be taken negative without damaging ripple effects. Fed officials know this and are understandably hesitant to experiment with negative rates.
So, if the economic reopening continues to slow (perhaps even more so if Covid-variant cases continue to rise), the Fed isn’t likely to choose negative rates as its policy response.
What will it do?
We’ll come back to that in a moment…
***On the other hand, what about the potential for raising rates?
Yesterday’s headline news was that consumer prices increased 5.4% in June, compared to one year earlier. That’s the biggest monthly gain since August 2008.
Meanwhile, excluding food and energy, inflation increased 4.5%. That’s the largest move since September 1991.
Responding to this news, Federal Reserve Chairman Jerome Powell said this morning that the economy needs to improve before he’ll change his ultra-easy monetary policy.
Powell dismisses the rising inflation as largely transitory, saying, it “has increased notably and will likely remain elevated in coming months before moderating.”
But at some point, if inflation doesn’t prove transitory, rates will have to climb to snuff-out runaway inflation. If not, Americans will feel a very real cash-crunch just to maintain their current lifestyles.
In fact, they’re already feeling it. I snapped this photo last night as I entered a restaurant for dinner.
Returning to inflation and Fed policy, the problem is the Fed doesn’t want to raise rates too far.
And why’s that?
Because the cost will be astronomical for the government.
The Committee for a Responsible Budget reports that the federal government spends more on its interest payments right now than it does its programs related to on science, space, technology, transportation, and education…combined.
This year, the federal government will spend $300 billion on its national debt interest payments.
How big is that?
It’s nearly 9% of all federal revenue collection. Or, for another perspective, it’s more than $2,400 per household.
Again, this is just to pay interest on the national debt – it doesn’t reflect any dollars going toward paying down the debt itself.
And remember, this is with rates basically at 0%.
What happens when rates climb?
Break out your checkbook…
From the Committee for a Responsible Federal Budget:
Higher interest rates will mean higher interest payments and deficits.
For example, if interest rates were one percent higher than projected for all of 2021, interest costs would total $530 billion — more than the cost of Medicaid.
If rates were two percent higher, interest costs would total $750 billion, which is more than the federal governments spends on defense or Medicare.
And at three percent higher, interest costs would total $975 billion — almost as much as is spent on Social Security benefits.
On a per-household basis, a one percent increase in the interest rate would increase costs by $1,805, to $4,210.
I’ll let you do the math on what your family’s check size will be if rates eventually climb 3% higher (and remember, that’s just interest… your personal share of the national debt and its unfunded liabilities, as a tax-payer, is about $675,000).
So, we have a Fed that doesn’t want to take rates lower if growth slows, yet also doesn’t want to take rates too much higher if growth soars.
What does this mean?
In short, it means an environment of low rates and a sea of liquidity that will drive certain asset prices north.
***What to expect from the Fed in the next crisis
Let’s start with the next slow-growth crisis.
We’ve discussed why the Fed won’t take rates negative. Or if it does, it will happen only after they’ve tried other measures…which are the measures that will support asset price growth.
Specifically, we can expect to see more aggressive asset purchases, as well as a tsunami of liquidity meant to backstop various financial markets.
But I suspect there will be a difference next time…the Fed buying stocks.
Think that’s crazy?
Don’t forget that we took a step closer to that back in March 2020 when the Fed began buying corporate bonds. Why is it so hard to believe that stocks would be the next domino to fall?
In fact, a survey from UBS finds that about 45% of respondents said they could see the Fed buying stocks in the next crisis.
And we already know they’ll be buying Treasury bonds, corporate bonds, and mortgage-backed securities too. So, expect a flood of government dollars into those asset markets.
On the other hand, what about an inflationary crisis?
Well, as we pointed out, the Fed’s own balance sheet restricts its ability to raise rates too much without risking some sort of fiscal meltdown.
So, while we can expect higher rates to some degree, don’t expect anything like we saw in the 1970s and early 1980s, when then-Fed-Chair Volcker took the Fed Funds Rate up to 20% in June of 1981. Can you imagine what that would do to the national debt service?
This means there will be a practical ceiling on rates, which calls into question how effectively we’d be able to combat a snowballing inflation problem.
Unfortunately, a limited-effectiveness interest rate policy would mean inflation continues to erode the dollar. But that would also push asset prices higher in everything priced in those inflated dollars.
As you can see, in either scenario, we have tailwinds that will pump up (or, at a minimum, support) asset prices.
Of course, there’s a third scenario in which a crisis is so great that the Fed can’t stop the carnage. Let’s cross fingers we don’t experience that.
***Bringing it all back to “now” and how Louis Navellier is playing this market
Right now, inflation is rising while yields fall. And that means one thing according to famed investor, Louis Navellier…
Fundamentally strong stocks are headed north.
For newer Digest readers, Louis is a market legend. Over the decades, he has developed a high-tech trading system guided by preset algorithms – basically, step-by-step computer instructions. It’s this use of predictive algorithms that led Forbes to name him the “King of Quants.”
Given the emphasis on numbers and quantifiable data, it’s no wonder that Louis has been closely watching what’s been happening with interest rates around the globe.
Last week, Louis updated his readers on the relationship between falling yields and rising stocks.
From Louis:
A brief collapse in bond yields around the world hit markets hard (last) Thursday.
The recent catalyst for falling yields was the European Central Bank’s (ECB) announcement Thursday it would tolerate up to 2% annual inflation over the “medium term” — essentially ignoring its current inflation target of just below 2%.
That might not sound like a big deal, but it represents the first major policy shift for the bank in two decades and it spooked investors…
The yield on the U.S. 10-year Treasury note dipped to 1.25% on Thursday, the lowest rate since February, but quickly rebounded this morning to 1.35%.
As I write Wednesday morning, the yield sits at just 1.36%.
Back to Louis for the takeaway:
Falling interest rates make bonds less attractive, which I see as unbelievably bullish for stocks, especially for a select group of stock I found with my Accelerated Income Project 2021.
We’re running long, so I won’t dive into the details of Louis’ new system, but I encourage you to click here to watch the free video Louis put together describing it.
In short, Louis says his system offers “the potential for large ‘paychecks’ in a short time. And it’s a strategy you can apply consistently. That’s because it works by targeting high-quality companies – the ones that grow and profit when others simply cannot.”
Given this spike in inflation we’re experiencing, it’s more important than ever to find a way to generate cash returns that are above and beyond the inflation rate.
On that note, Louis is recommending a brand-new stock he found through his Accelerated Income Project 2021 today. Click here to learn more.
Wrapping up, it’s going to be fascinating to see how the Fed tries to navigate this interest-rate/inflation challenge. However it plays out, we’re now in an inflationary environment. And whether it gets worse, or whether yields plunge and go negative, we’re still looking at inflated asset prices.
Make sure you’re ready.
Have a good evening,
Jeff Remsburg
