Continuing this week FOMC MeetingThe Federal Reserve kept the federal funds rate in the range of 5.25% to 5.5%. No wonder.
But the real dirt was buried. Implementation Notes. Right here, the Fed announced that starting June 1, it would reduce its monthly balance sheet drawdown of Treasury securities from $60 billion to $25 billion. In other words, it would have to issue $105 billion less Treasuries in the third quarter.
Essentially, the Fed is trying to keep rising interest rates in check. Perhaps this will buy the Fed and the overextended financial system some time in the election year. But with persistently high consumer price inflation and a balance sheet that is not yet finished, $7.4 trillion, This boiling pot is bound to overflow.
Because there are much bigger factors at play than Fed monetary policy. If you understand the mechanics of what’s happening, you’ll be way ahead of 99% of your peers, and even many of the so-called experts. Where to start?
yesterday [Thursday]And despite the Fed’s tapering announcement, the 10-year Treasury yield closed at 4.58%, well below its 16-year high of 5% set in October. After months of retreat, yields are rising again.
And as yields continue to rise and credit markets continue to tighten, this one thing will change everything. In fact, it already has.
The world we have entered, the world of rising interest rates, is a strange one. Americans have not experienced it for more than 40 years. But it is nonetheless part of the long-term, secular movement of the credit cycle. To understand what is happening, we only need to look back and identify a few key inflection points.
Interest rates and asset prices
In September 1981, something significant happened. The rising part of the interest rate cycle reached its peak. At that time, interest rates had been rising for more than 40 years. People probably thought they would continue to rise forever.
But something unexpected happened. Interest rates didn’t go up. They went down. And they didn’t just go down, they went down for 39 years. And in doing so, the seeds of catastrophe multiplied and spread across the land.
The relationship between interest rates and asset prices is generally simple: when credit is scarce, asset prices generally fall. When credit is scarce, asset prices generally rise.
When credit is cheap and abundant, individuals and businesses increase their borrowing to buy things they would otherwise not be able to afford. For example, individuals who take out huge jumbo loans drive up the price of their homes. Businesses with an endless supply of cheap credit borrow money to buy back stocks, which inflates stock prices and the value of executive stock options.
When credit is tight, the opposite happens. Loans are used only for activities that promise high returns. Returns that exceed the high interest rate. This has the effect of lowering the price of financial assets.
In 1981, credit was expensive, but stocks, bonds, and real estate were cheap. Believe it or not, interest rates on 30-year fixed-rate mortgages were at an all-time high. 18.45 percent In 1981. That year, Median sale price of a U.S. home It was about 70 thousand dollars.
Meanwhile, the rate for a 30-year fixed-rate mortgage bottomed out at 2.68% in December 2020, and the median price of a U.S. home rose to a high of $479,500 by the end of 2022. Prices have risen even more sharply along the east and west coasts of the country.
Likewise, the Dow Jones Industrial Average (DJIA) was around 900 points in 1981. Today, the DJIA is around 38,225 points. That’s an increase of more than 4,147 percent. But over the same period, Gross domestic product It only increased by about 805%.
Trend reversal
Nearly 40 years of increasingly cheap credit have been a major driver of the surge in stock and real estate prices. Asset prices and other financialized costs, such as college tuition and automobiles, have also been severely distorted and deformed by 40 years of increasingly cheap credit.
Moreover, the imbalance between high asset prices and low borrowing costs has caused a global catastrophe. When interest rates rise, asset prices must fall. As of the end of last year, the median sale price of a U.S. home fell to $417,700, down more than 12 percent from its peak.
There is no doubt that the Federal Reserve exerts an extreme and coercive influence on credit markets. However, the Federal Reserve is not the master of credit markets. In fact, the Federal Reserve’s interventions in credit markets are secondary to the overall long-term trend of interest rate cycles, both upward and downward.
From a historical perspective, today’s 10-year Treasury yield of 4.58% is slightly higher than the long-term average of 4.49%. But if you look at just the past three years, it’s incredibly high.
Specifically, the 10-year Treasury yield hit a low of just 0.62% in July 2020. Today, it has risen dramatically to 4.58%. Over the past 46 months, the 10-year Treasury yield has risen by a total of more than 638%.
The last time the interest rate cycle bottomed was in December 1940, when the 10-year Treasury yielded 1.95%. After that, interest rates generally rose for the next 41 years.
What few people alive remember is that when the Federal Reserve adjusts the federal funds rate, the impact is dramatically different during the rising and falling periods of the interest rate cycle.
Disaster Policy
From 1987 (with the advent of the Greenspan Put) through 2020, whenever the economy was weak, the Fed cut rates to stimulate demand. In this disinflationary environment, credit markets limited the negative consequences of Fed actions.
Of course, asset prices rose and incomes stagnated. But consumer prices did not skyrocket. The Fed interpreted this as meaning that the business cycle had been tamed. This was far from the truth.
The Fed’s interest rate policy has repeatedly failed during rising interest rate cycles since the United States violated the Bretton Woods agreement in the 1970s.
During that decade, as today, Federal Reserve policymakers were politically unable to get ahead of interest rate increases. Their efforts to artificially keep the federal funds rate low to stimulate the economy have not had the desired effect.
In this scenario, and as we have experienced since July 2020, monetary inflation and deficit spending combined to create consumer price inflation. Federal policy during the rising interest rate cycle is a disastrous policy.
In July 2020, interest rates finally bottomed, some 39 years after their last peak. Now yields are rising again, and the Fed can’t stop them. In fact, they could rise for another 30 years.
This means that credit will become increasingly expensive by the middle of the 21st century. So the world of ever-falling interest rates, the world we’ve known since the early days of the Reagan administration, where you can refinance your debt every few years and reduce your debt burden, is over.
Unfortunately, all of this is happening right now. record Household, corporate, and government debt. It will take some practice for households, businesses, and investors to learn how to navigate a world of rising interest rates safely. Those who are burdened with debt will undoubtedly go bankrupt.
The impact on government budgets and interest payments on debt will be unbearable, resulting in a serious devaluation of the dollar.
[Editor’s note: It really is amazing how just a few simple contrary decisions can lead to life-changing wealth. And right now, at this very moment, I’m preparing to make a contrary decision once again. >> And I’d like to show you how can too.]
thank you,
MN Gordon
For Economic Prism
Returning from Disaster Policy to the Economic Prism
