by Turd Ferguson, TF Metals Report:
Ahead of The Fed, our own AGXIIK submits a post today that I think you’ll find to be both enlightening and educational.
I’ll add my own comments and charts after the dust settles from the CPI. For now, though, many thanks to Craig for this.
TF
Powell’s Conundrum, by AGXIIK
My opinions may not be shared by others but since I’ve been through 4 major financial crises including the wretched stagflationary period of 1976 to 1982 during which we saw prime rate hit 21%, these events helped me form a few opinions along the way.
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In May 2023 Jerome Powell, president of the Federal Reserve Bank, increased the Fed Funds rate for the 10th time, adding another 25 basis points to the rates.This brought prime rate to 8.25 %, the highest in almost 20 years. This round of rate increases was the most rapid in US history, reflective of the Fed’s slow realization that inflation was real and tangible and not transitory as first thought.
From this point in the second quarter of 2023 and going forward, I’m fairly certain we’ll see another 25 BPS increase in Fed Funds and Prime rate, possibly within a month or two barring some unexpected event that causes Powell to pause in his plans..
A dramatic decline in the present inflation rate or wide recognition of a strong recession could provide reasons for Powell to stop. Either event might even incline Powell to reverse course and drop rates quickly. The 2024 presidential election cycle is another event that generally produces lower rates, pump priming and heightened monetary stimulus. Federal Reserve Presidents often succumb to political pressure and, while Powell’s been pretty much flinch-proof lately, that could change quickly if historical Fed actions are any guide to near term Fed actions..
With a recent CPI print at 5% Powell may still be compelled to increase rates another tick or two to put the final kibosh on inflation. Yet other factors might have him pause as he reflects on the damage that’s been done by 10 rate hikes in the last 17 months. Damage is evident pretty much everywhere we look, not least of which are the financial conditions of most small and mid sized banks and unsteady commercial real estate values. Predicting Fed actions could be considered a blood sport especially if the consequences of mistakes in recent bets placed are any guide. We’ve seen trillion dollar damage reports as the CEOs of some of the largest businesses failed in their task of assessing what Powell do.
A couple of small rate hikes over the rest of the year might help staunch inflation yet consequences could easily turn out to be grave including a serious recession, a big drop in the stock market, further damage to the lending sector or deleterious effects on real estate values. D, all of the above, is also possible. Anyone caught looking as Powell chooses one course over the other gets their head handed to them. Correct guesses literally mint new billionaires overnight. as this is a craps game at the highest levels.
This means nothing is easy for Powell. He’s still in a tough spot as to whether he should hike again, pause for a period of time or turn rates back down. If he continues pressing rates upwards through 2023 before a nominal pivot sometime in late 2023 or at least by early 2024, this will further exacerbate American economic conditions along with inevitable knock on effects felt worldwide. It’s a well accepted fact that things are breaking now as a direct result of the fastest rate hikes in US history but the china closet is filled with fragile objects. Everything remains at risk as the Fed bull charges around the shop.
What will break first? Will it be the American economy or Powell’s will to beat inflation? Looking back to the 1980-1982 period, Paul Volcker, the former President of the Fed, did pause and pivot, only to see inflation spike again coupled with two back to back recessions. He quickly reversed course by going back to well tested rate hike policies which finally broke the back of inflation in the 1982-84 period.
As Powell reads his monetary history he’s caught in a heck of a squeeze; bump the prime rate to 8.5% within the calendar year of 2023, maybe even giving a couple more shots to quell inflation as he presses rate pedal to assure himself that he doesn’t make the same mistake as Volcker who let off rates before inflation was well and truly dead.
This pathway might tamp down inflation in the long term but it’ll add to the cost of living and doing business going forward. Interest is, by its nature, an inflationary cost. It’s passed down through cost chains, effecting all expense factors whether loans are in place or not. Even if rates stabilize at these higher levels it leaves us with a substantial increase in the US debt and more inflation.
As all government costs galloped higher, the interest paid on $32 trillion in Federal debt also rose rapidly. The really painful part is that inflation can linger years when prices cannot decline due to these cost factors. It almost seems like we’re stuck with much higher prices for some time to come.
$2 trillion here; $2 trillion there and pretty soon we’re talking about real money. In federal debt terms, as we move to the end of 2023 we’ll see another $2 trillion in debt as far as the eye can see. Moving through the federal fiscal period of 2024 and into 2025 we’ll have a minimum of another $2 trillion in US debt notwithstanding monetary pump priming in the Presidential election cycle. No matter who’s crunching the numbers the basic math is pretty simple. Debt will multiply and expand like weeds or rabbits.
The debt ceiling resolution provided nothing substantial in spending caps. We could easily see even higher deficit spending which, in and of itself, is grossly inflationary. Federal spending and debt on an unrestrained path is one of the largest heads of the Inflation Hydra. It’s very hard to kill as it make its presence known in all debt markets while this spending pushes out other investments that require reasonably priced loans to function.
Seldom mentioned in this rapid expansion of US debt is the big negative to the US credit rating. Even while it weighs heavily on access to all capital it’s made worse when interest costs are added to these gargantuan totals. Half the Federal deficit is now interest on the debt. That annual borrowing cost is $1 trillion, a sum that’s exceeded only by Social Security costs. 40 years ago the US debt was $1 trillion. Now it’s just the interest on this debt In reality, the US treasury is playing “smoke and mirrors”, financing the interest costs by tacking it on to the federal debt instead of being paid as we go.
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