June 16, 2022

How The Fed's Battle With Inflation Affects You And Me

Yesterday afternoon, at precisely 2 pm, word came over our collective terminals that the Federal Reserve had raised its core interest rate target by 75 basis points.

At the high end of many expectations on Wall Street, and the biggest jump for more than twenty years.

I think that one trader put it best when he said that the Fed had to establish its credibility. Either they were serious about fighting inflation, or they weren't. And this was the best the Fed could do in going after their old nemesis.

By raising rates three-quarter percent, the Fed is officially declaring that the battle is on. Their number one enemy will henceforth be inflation.

But it could not have been an easy decision. Since the Great Financial Crisis of 2008, it has been the unofficial policy of this central bank to have a Zero Interest Rate Policy. The sole exception to that was the four-year term of Donald Trump's Presidency.

So for 16 of 20 years, the members of the Fed's Open market committee simply voted “no interest.” Simple straightforward.

Things began to change at last month's meeting when the Fed voted to raise rates by 50 basis points, and now 75 basis points.

There are many ramifications to this new Fed Strategy. Ramifications that I'm sure weighed heavily upon their decision.

The very first thing that will happen, now with higher rates, is that the Fed's own portfolio of US Government Bonds just lost value. And with a total market value of just under $9 Trillion dollars, this is not an inconsequential event. Rumor has it that the Fed is already at a negative equity position, this will drive them further underwater.

And speaking of US Treasuries, they just became more expensive to finance. As the interest rate on each new bond will now be higher than before. In other words, the interest expense for the US Government just increased. And it already is well over $340 billion dollars per year.

But we don't stop there. All those short-term loans, that revolving credit will shortly hike their rates, if they haven't already. Credit Cards, Home Equity Loans, Commercial Paper. All those clever ways to provide instant cash, just tick up a notch.

In short, this is going to hit us all in the wallet. From giant corporations to small credit card spenders our interest expenses just climbed.

We are a nation that is built on debt. There are actually major corporations, which are capitalized almost entirely with debt. Corporate America spent a decade or more replacing shareholder equity with debt. It was called the “Stock Buy Back”. And the practical effect was that management bought out the company shareholders, by borrowing.

Well, that borrowing just became more expensive. And the squeeze begins right now. It's the dirty little secret that Wall Street doesn't want to talk about.

We'll have much more to say about this in the future.

The sum total of all this is that eventually, people will stop spending. Frankly, I've been amazed at how long people have continued to spend. But perhaps that's also ending right about now.

Did you notice that big “miss” by Wall Street analysts on yesterday's Retail Sales Reports? This is a key metric for the Street, and they usually don't miss that bad on Retail Sales. But there is was sales were not up the 2/10ths% the Street thought they would be. Sales actually crashed to a negative 3/10ths%. And not only that, they had to revise the months before sales were lower also.

It's a very bad sign for the consumer. And I believe the beginning of more to come.

So the Fed is now firmly committed to a new financial path. It's a Battle Royal, the Fed versus Inflation.

And whether we like it or now, we are all going to be dragged along.

Economic News

Along with the current interest rate decision, The Fed also gave us their projection for future interest rates. Remember that 1.9% rate they projected just last month. Well, we can throw that one out the window.

Let's nearly double that, at 3.4% interest. And remember that's later this year. An awfully big change in rates ahead. And an indication that we're likely looking at some more 75 basis point jumps as the year progresses.

In any event, futures this morning are none too happy about this turn in Fed policies. And we seeing more big drops in equities, bonds, and cryptos. About the only green on the board are precious metals and agriculture futures.

Speaking of the Ag Sector. More bad news, as the impact of higher fuel costs is really hurting farmers especially here on the east coast. A Pennsylvania farmer reports this morning, that he can't even afford the fuel to run his tractor and plant some more corn. Ergo, those high ag futures this morning, and high food prices next harvest.

We're starting to see some real anomalies in the Global Economy. And nowhere is that more profound than in Japan. Japan, the export titan of the last century, is now starting to rack up trade deficits that only follow the US as the largest in the world.

For 10 months in a row now Japan, this morning reported yet another trade deficit. And even more concerning these deficits are growing larger and larger. Indicating that Japan like the US has become dependent on offshore products.

Is real estate starting to go soft? We'll get some real insight into the Real estate sector in just a few minutes, as the latest number of building permits and Housing Starts are released. These will be month-end May results.

And in looking at housing starts in particular we see that 2 out of the last 3 months have been negative. Not a good sign for new home sales in the fall.

Finally, we'll get initial claims for unemployment. Last week 229k filed for unemployment insurance, and that's what the Street expects today. So you should expect to sleep through this report. No change is expected.

However, I do note that one analyst is expecting a big jump in initial claims. If he's right, look out below, that would tell us that the economy is declining faster than we thought.

We've had some earnings reports already, with tech company KLAC and electronics company Jabil Incorporated both trading fractionally lower at the moment. Meanwhile defensive stock, grocers Krogers is trading fractionally higher.

Tech giant Adobe Systems will report after markets close.

Have A Great Day!