Fluffy Chicken Podcast Episode: America Is a business now F*ing Pay me!
There will be a recession in 2019-2020. The landscape is easy to follow and understand.
First, everyone needs to remember the worst stock market performance in the month of December occurred in 2018. The reason for the December collapse has all to do with interest rates. The easiest interest rate to peg the recession trajectory is to the 30 year bond yield. Between November-December, the 30 year bond yield hit 3.50%. The 30 year bond at 3.50% is what everyone needs to keep their eye on. The 30 year bond yield at 3.50% is the figure that billion dollar hedge fund manager Jeff Gundlach “king of bonds” believes is the watermark. The US economy simply has to much debt to handle a 3.50% interest rate on the debt.
Reasons for the 30 year bond yield hitting the 3.50% was due to the FED raising the FED funds rate and the process of quantitative easing.
The FED has two tools that manipulate interest rates. The most historically common is simply raising and lowering the FED funds rate. The second is the balance sheet tool. The balance sheet tool is also known as quantitative easing when the FED is growing their balance sheet and quantitative tightening when shrinking their balance sheet. This tool was introduced to handle the great recession in 2009. Quantitative easing is used to boost asset classes by introducing capital. However, introducing QE to the market is worrisome because it can erode our currency in an inflationary manor. Hence the reason the FED is going through a QT phase to protect the US dollar’s value.
In December we saw the 30 year bond touch 3.50% due to the FED raising the FED fund’s rate and due to QT. Since December the FED has stopped raising the FED fund’s rate and has stated they are prepared to stop the process of QT because manipulating the FED fund’s rate is no longer a strong enough tool to control long term interest rates like the 30 year bond.
Originally the FED stated we were going to go through QT on an autopilot method of $50B per month in order to shrink the balance sheet and protect our currency. They have since done a 180 degree turn and are ready to quit QT if warranted.
So what will ultimately lead the FED to stopping QT and perhaps entering QE once more? That answer will be faced in September 2019. In Sept. 2019 the government’s fiscal calendar begins. The US government will have to face the challenge of raising at a minimum $1.2T in government bonds to finance our government deficits. Meanwhile we are still in a phase of QT at the tune of $600B per year. The combination of trying to sell record amounts of debt at US bond auctions at almost historically low interest rates to the bond purchaser’s won’t provide enough return for the risk bond purchaser’s will have to take on. Thusly, low bond purchasing action at bond auctions means the bond’s will have to offer a more attractive interest rate. This action will increase the 30 year bond yield above 3.50%. This level again will strangle the US economy because of our high debt levels.
How will the FED react? They will react with the second tool-the balance sheet. The FED will have no choice but to stop QT and enter into another round of QE to artificially suppress interest rates. QE brings more US dollars into the market place ultimately eroding the US dollar because of the law of supply and demand. This then becomes an inflationary issue that will show its ugly head in 2019-2020.
The only unanswered question that I still have is- When we re-enter QE will this scare the world from buying US bonds forcing the FED to purchase even more through QE? How much in US bonds will the FED have to to purchase through QE to keep the 30 year bond beneath 3.50. Eventually all of this will have to be answered.
For years people have talked about the disastrous fait of the United States dollar. Those people have always been written off as quacks and go unheard. Well, After hearing Jerome Powell’s speech today, those quacks are about to be right.
Today Jerome Powell stated that the FED funds rate is at neutral. This assumption on FED funds rate differs from statements in the past. The new stance is clearly the result of how markets reacted in December when the FED continued to raise rates. Jerome Powell describes the market activity in his statement today as “crosswinds”. It is obvious that the economy can’t handle a “true neutral rate”. The only reason Powell was able to defend the current FED funds rate as a “neutral rate” is due to low inflation and low unemployment. Obviously these two things are great-but there are two obvious reasons why 2.25-2.50 percent can’t be the neutral FED funds rate.
First, the a neutral FED funds rate is not suppose to be accommodative or hinder economic progress. If inflation is slightly above 2% than the FED is still offering a real FED funds rate of 0%. Thus created an accommodative environment for moral hazards within the economy to keep growing bubbles.
Second, As Powell mentioned during his speech today, this means lowering the interest rate in times of crisis won’t be a strong enough tool anymore to jumpstart a spiraling economy. This lead Powell to candidly say that the balance sheet is in play to handle economic downturns. In 2008 we dropped the FED funds rate from 5% down to 0% and this wasn’t enough. We had to turn to a new experimental tool, quantitative easing (increasing the FED balance sheet via purchasing of bonds and bad debts) in order to quell an economic crisis.
After Jerome Powell’s statement today reports asked questions pointed that this was the “Powell Put”. This is a negative connotation used after FED chairman Alan Greenspan blew bubbles in the late 80’s, 90’s, and early 2000’s by constantly slashing interest rates that piled on debt until the chickens came home to roost in 2008. The truth is that this is the “Powell Put”. Only he has a second tool Alan Greenspan didn’t get to take advantage of-blowing up the FED reserve balance sheet.
So why are the Quacks that have been predicting the demise of the US dollar finally going to be proven right? Well, Jerome Powell just said himself that he is prepared to blow the up the balance sheet. In the last ten years the FED has constantly said they will clean the FED balance sheet at a rate of $50B per month. Well, as we saw in December, this caused great turmoil in the markets. We can’t tighten the money supply. So, Jerome Powell is using the “Powell Put”. He is stopping rate hikes and will inevitably stop Quantitative tightening, although he wouldn’t answer questions about the QT program after his speech.
We will inevitably have another recession. Its a 100% certainty. Some predict 2019-2020- I happen to agree with them. Whether we are right or wrong is neither here nor there. There certainly will be another recession. When that happens the FED has shown their hand that they will combat the problem with expanding the balance sheet-as Jerome Powell stated today. The way the FED expands the balance sheet is simple. The FED creates digital USD to buy bonds. This expansion of USD that are available increases the supply of USD and destroys the value. This is extremely troublesome as the US imports everything with our massive trade deficits. These deficits will be on steroids when our USD doesn’t buy as much as it had in the past.
So finally-the quacks will be the smartest people in the room. Assets like Gold, Silver, and oil that trade against the USD will be great places to be until they turn into a bubble that everyone will wish they were apart of from the beginning. They will mention the quack cousin that got “lucky”. They will say it was something that nobody could have predicted. When in fact, the FED chairman told everyone what was going to happen from the beginning.
Our current positions are in commodities that go against the US dollar. Owning physical metals is a great defensive position to be in. Owning ETF’s like USO (oil), SIL (Silver), and gold stocks with low debt are a fantastic offensive investment to be in.