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The Federal Reserve is being put to the test. They will be soon forced to either defend the dollar or defend the economy.
They cannot do both.
The Federal Reserve will release their latest policy decision tomorrow afternoon. The Fed’s urgent move this week will force them to raise interest rates and take a hawkish stance. The show of force will look like an attempt to defend the dollar.
Should stock and bond markets continue to crater as they have in the last few days, the Federal Reserve will likely be forced to “blink.”
Then they’ll be forced to defend the economy.
The scary part is that they may not be able to do that either.
Friday’s CPI number has once again embarrassed the Federal Reserve and anyone holding financial assets is paying the price for it.
Inflation readings on Friday came in at 8.6%, a number that was dramatically higher than economists' expectations of 8.2% [1]. Stocks have since fallen 9%. Treasuries have also declined, falling over 3% in the last three trading days.
It’s all because of the mistake the Federal Reserve has already made.
We are all now watching an accident unfold in slow motion.
Since the beginning of the year, we have been pounding the table that the Federal Reserve was far behind the curve. We believed that every month when CPI numbers were announced, it would put new pressure on the Federal Reserve to take action against the inflation we have long been arguing was raging inside the system.
The Fed is now stuck. Anyone holding risk assets should be prepared to hang on for dear life for what will likely be a very bumpy ride.
Here’s the simple analysis on the macro level.
- We are in a highly levered economy.
- The Federal Reserve created an asset bubble with extremely accommodative policies.
- Too much money in the system fueled inflation.
- Inflation is a monster the Federal Reserve first desired, then denied, and has been ignoring.
- Their irresponsibility has created the worst inflation in over 40 years.
- This game of "liar" has been played every month as CPI continues to come in hot.
- These hot readings force interest rates to “reset'' causing carnage in the equity and bond markets.
- The “beast” inside the market then forces the Federal Reserve to hike rates faster.
- Rates High? Stock Die!
- Rinse and Repeat.
The same story that has been playing out all year happened again Friday when CPI numbers were released.
Interest rates have since surged higher.
We must appreciate the incredible increase in bond yields and what they indicate. In just six months, the yield on the 10 YR Treasury has risen from 1.47% to 3.46% today. The speed of the move is what has investors running for cover.
Friday’s embarrassingly high CPI print means that the Federal Reserve will have to hike rates more aggressively than they have been promising. We are now in the “Powell has egg on his face” moment. The near-term result will be that the Federal Reserve will be forced to come out swinging tomorrow.
It’s the only way to save their credibility.
The Federal Reserve is likely to raise interest rates by 75 basis points tomorrow, not the 50 basis points we had all been promised.
The Wall Street Journal yesterday floated the idea that the Federal Reserve was considering 75 basis point hikes. Their call was quickly followed by financial broadcasters Steve Liesman and Scott Wapner at CNBC. Next came Goldman Sachs, the Fed’s mouthpiece, who adjusted their expectations from 50 to 75 basis points for tomorrow’s big decision. Now virtually every investment bank is calling for 75 basis point hikes.
Worse still the Fed Funds “neutral rate” has been repriced to 4% by the end of the year. This means that the Federal Reserve would need to raise rates another 3.25% over the next six months from where we stand today.
Making matters all the more urgent for investors is that tomorrow is “dot-plot” day where the Federal Reserve projects future rate hikes. If the dot plots match the most recent neutral rate of 4%, markets will likely see one heck of a volatile time in the coming days and weeks.
If you think this all sounds bad, keep reading...
The massive reset in interest rate expectations in the last few days has once again triggered the world’s favorite leading recession indicator.
The yield curve is inverting and the check engine light on the U.S. Economy is blinking red once again.
Late last night the yield on the 2 YR was at 3.375%. This occurred while the yield on the 10 YR paid 3.36%, and while the yield on the 30 YR hit 3.35%. This means the 2 YR note paid more interest than that of the 5 and the 30 YR treasuries. This, by the way, is the first time the yield on the 2 YR Treasury and the 30 YR Treasury has flipped since 2006.
This is called inversion.
The problem with yield curve inversions is that they have a perfect track record of predicting recessions. Each and every time the yield curve has inverted in the last 70 years, it has signaled an imminent recession.
Brentwood Research explained this scenario in-depth in our March “Check Engine Light On the US Economy.” Our video explaining the yield curve inversion is one of our most-watched episodes. We urge anyone who is looking to get a glimpse of the future to watch this episode.
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