$4 Trillion in Stimulus and Negative Interest Rates could propel gold and the TSX Venture to new highs.
It has become obvious the Fed will not raise rates, that the Fed cannot raise rates. Just read the economic data coming out week after week and this becomes a matter of fact. But a Fed Staff working paper reveals it has other plans… Remember, the average quarterly GDP for the past 3 quarters fell to below 1% after fresh revisions to growth. Capital spending and weak productivity have declined persistently in recent quarters.
Fed plans for lower rates and $4 trillion in stimulus
Zero Hedge broke a must-read story last night, which highlights a Fed Staff working paper released over the weekend titled “Gauging the Ability of the FOMC to Respond to Future Recessions”. It was written by the deputy director of the division of research and statistics at the Fed and highlights a scenario that would see the Federal Reserve print an additional $4 trillion to ward off a severe recession.
The long and short of it is this: the Fed has not changed its game plan. If the market slips into recession, its plan is to initiate large-scale asset purchases and provide “forward guidance about the future path of the federal funds rate”, according to the author.
Again, the Fed assumes these two functions will calm the markets and breathe new life into the economy.How can they think this with a balance sheet of nearly $4.5 trillion, years of ZIRP and no results? It is their only play at this point. With no real growth and inflation, stagflation has been the result. The Fed would bankrupt the country by raising rates as the U.S. already spends more than half a trillion on interest each year. So, higher rates are not in the cards.
Check out the below excerpt from Zero Hedge:
The study engaged two simulations:
- the economy is in equilibrium initially with inflation at 2%, r* at 1%, so equilibrium nominal fed funds is 3%
- the economy is in equilibrium initially with inflation at 2%, r* at zero (secular stagnation) and equilibrium nominal fed funds at 2%
Now, below are the policy responses:
“The first assumes a linear world where fed funds can go into negative territory but there is no breakdown in the structure of economic relationships. It is probably not a realistic view of policy ineffectiveness at negative rates, but it is mean to be a baseline. The second just takes fed funds down to zero and keeps it there long enough for unemployment to return to baseline.
The third takes fed funds down to zero and augments it with additional USD2trn of QE and forward guidance. A variation on the third policy response function doubles the amount of QE in the second simulation.”
Zero Hedge clarifies that,
“In other words, the Fed is already factoring in a scenario in which a shock to the economy leads to additional QE of either $2 trillion, or in a worst case scenario, $4 trillion, effectively doubling the current size of the Fed’s balance sheet.”
This could prove disastrous for the U.S. dollar and the Fed’s balance sheet. We wrote about this issue over the weekend in A World Currency is Born:
“Remember, the Fed’s balance sheet has already been tapped and sits at $4.5 trillion. The Fed won’t be there to bail out big banks and the rest of America when the next crisis hits, unless it wants to turn U.S. dollars into confetti overnight.”
Federal Reserve balance sheet sits stubbornly above $4 trillion
Click here to read the full report A World Currency is Born.
Wall Street expert, James Grant, has been warning of a crash in the sovereign debt markets for some time. Below is his response in a recent interview on the question: Where do you see the biggest risks?
“Sovereign debt is my nomination for the number one overvalued market around the world. You are earning nothing or less than nothing for the privilege of lending your money to a government that has pledged to depreciate the currency that you’re investing in. The central banks of the world are striving to achieve a rate of inflation of 2% or more and you are lending certainly at much less than 2% and in many cases at less than nominal 0%. The experience of losing money is common in investing. But where is the certitude of loss even before your check clears? That’s the situation with sovereign debt right now.”
The September rate hike is off the table. The Fed simply cannot raise rates into this weak economy; and, even if it wanted to do another symbolic quarter move point, it would never risk doing so with the election just two months away. Don’t believe the ‘tough talk’ and stay long equities, at least until the election on November 8th.
This article represents solely the opinions of Alexander Smith. Alexander Smith is not an investment advisor and any reference to specific securities in the list referred to in the article does not constitute a recommendation thereof. Readers are encouraged to consult their investment advisors prior to making any investment decisions. The information in this article is of an impersonal nature and should not be construed as individualized advice or investment recommendations.