Yesterday, the Fed surprised no one and left its key rates unchanged and gave no indication that the committee was preparing to raise or lower rates anytime in the foreseeable future. As always, the market reactions were much more interesting and unpredictable. In this case, bond markets barely changed, the U.S. stock market jumped, and Euro futures strengthened slightly against the U.S. dollar.
Although few monetary hawks felt that there was any reasonable chance for an inflation-fighting rate hike this week, there was hope that lone FOMC dissenter Richard Fisher would be joined by other committee members in voting against the current round of liquidity injections. No such luck there. For now at least, Mr. Fisher is still a one man band. The rest of the Committee still shows no stomach to really take on inflation (despite this week’s alarming CPI report) and plenty of willingness to push back on the gathering recession. As a result, my feeling is that the next rate move will be down.
Last summer I predicted on CNBC’s Kudlow Show, that the Fed would lower rates from 5.25 to near 1.00 percent and that the U.S. dollar would continue in relative decline. I was scoffed at and ridiculed. Well, I believe that today’s Fed Statement indicates that rates will soon head south, towards 1.00 percent or even lower.
On July 3rd, this summer, I predicted, again on Kudlow’s show, that oil would soon drop in price, due to demand destruction. Again, I was ridiculed. On the very next business day, oil began to fall. Two days later it reached the peak, from which it has since fallen dramatically as the recession of which I have long warned has become clearer.
I say these things not to boast, but to lend weight to my arguments and warning of impending hyper-stagflation. Facing the prospect of both inflation and recessionary forces, the Fed is boxed in.
As a student of the Great Depression, Fed Chairman Bernanke has correctly, in my view, sensed that whereas inflation does the greatest long-term economic damage, it is recession that his political masters most fear. He is also aware that it was the raising of interest rates that turned the 1930 recession into the Great Depression of 1933, which lasted until World War II.
Depression, especially in a highly leveraged world that is accustomed to prosperity, would likely result in serious civil strife. Politically, it must be avoided no matter what the economic or financial costs. Despite ‘spin-talk’ to the effect that the Fed is pursuing a dual mandate to both fight inflation and promote growth, in reality they are simply trying to promote growth pure and simple. This is the reality that few market analysts or journalists dare to mention.
With 5 million American homes vacant, the “Big 3??? auto giants heading towards bankruptcy and some $4 trillion already wiped off of American home values, things look bad for American consumer demand. With consumer spending accounting for 72 percent of GDP, this should ensure recession. To try to change this outcome, the Fed stands ready to implement the most inflationary monetary policy in its history.
Looking ahead, Nouriel Roubini, the former Clinton White House economist, forecasts credit losses will amount to some $2 trillion. So, while the Fed has applied Band-Aids to the financial crisis, the evidence is that internally, financial institutions are still bleeding fast.
The latest fall in commodity prices has given Fed Chairman Bernanke the wiggle room that he has hoped for desperately these past months. The pullback in oil and other commodities will give him the golden opportunity to lower interest rates further to avoid the looming recession from morphing into depression.
Investors should expect falling worldwide interest rates. Short-term government bonds in inherently strong currencies, like Swiss Francs, remain attractive. As hyper-stagflation and acute financial stress becomes manifest, gold will likely rise significantly.