Another Week of Fed Speak

 Almost without fail, every time the Federal Reserve Chairman speaks, the stock market declines. This week Chairman Powell reiterated that they will continue to raise rates for as long as necessary. I wonder why we need the Fed at all. A case in point. If a consumer has been putting items on their credit card at 10%, then their rate climbs to 15%, the odds are that they will limit their spending. Where does the Fed fit into this? They do not. That is the rub.

We do not need the Fed raising rates, because consumers will restrain their spending on their own when rates go up. Look at housing and mortgages. When rates go up, it does not affect cash buyers. It only affects people who need a mortgage to buy a house. At a 4% mortgage, they could perhaps have afforded a 2,500 square foot home. However, at an 8% mortgage, they may only qualify for a 1,800 square foot home. Unless they are in a forced move situation like a job transfer, then odds are they will wait until interest rates decline to buy more house for the money. Again, where is the Fed in this scenario? We do not need the Fed to tell us when to buy a mortgage. We can make that decision all on our own.

Therefore, the Fed raising rates only throws gasoline on the fire. The Fed's actions will do a few things, none of which are good for the average person. They will force people to pay higher interest rates. They will force large corporations to lay people off. They will force banks to quit loaning money or make it very restrictive to qualify for loans. The Fed does all this in order to get interest rates to decline. Yes, they raise rates for an extended period in order to get interest rates to decline. In other words, they inflict severe financial pain on most Americans. It is stupid. (My favorite word.)

Later this month, it is now expected that the Fed will raise interest rates another 0.50%. They do not need to do this. People will stop spending on their own. Rates are already high enough to curb credit card spending and mortgages. When the Fed raises rates, they put banks at financial risk, because people with 24.99% credit card rates are going to say, "To hell with it. I ain't paying this no more." The banks who issue credit cards will have to go after these people and their recovery prospects are diminished. There is only so much money banks will spend chasing down bad credit card debt. Most banks will write it off, then sell it to bill collectors who will hound the hell out of people trying to collect.

In my opinion, we do not need the Fed if this is their planned outcomes. Ron Paul was right.

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Failed Thinking of The Federal Reserve

Investing is really about looking into the future and trying to determine the direction of the markets in the short and long term. The Federal Reserve does this along with individual investors. There are a couple of reasons as to why things have changed as far as the global markets are concerned. One reason is that the Federal Reserve is no longer buying bonds on the open market which was commonly considered stimulus to the U.S. economy. Instead, the Federal Reserve has quit buying bonds on the open market and let the bonds that they bought previously just mature in a normal and orderly schedule. This action by the Fed causes significantly less demand for bonds and with less demand comes higher interest rates. They have over four trillion to unwind from their balance sheet. That is close to 20% of the U.S. debt.

The second reason why things have changed is because the Federal Reserve has been raising interest rates. The failed thinking of the Federal Reserve Board of Governors is that "this is the way it has always been done." They justify raising rates to keep a lid on inflation, because this is the way it has always been done. In the Fed's mind, inflation is a bigger risk than the U.S. debt.

When you add these two reasons together, then you kind of have a double whammy on the economy that will stifle growth.

As I look back in my lifetime, I can remember Paul Volcker, Alan Greenspan, Ben Bernanke, Janet Yellen and now Jerome Powell. Did any of these people do their jobs in an exceptional manner? In my opinion, no. It is a fallacy to believe that the Federal Reserve Chairman or Chairwoman can actually control the United States economy like the CEO of a business. They all made the same mistakes. They continued the failed policies of their predecessors with a "this is the way it has always been done" mentality.

My question would be this. If we owe close to 22 trillion in debt and the Federal Reserve raises interest rates on that debt, then wouldn't that increase the total debt at a faster clip? The answer of course is yes.

Let's take the reverse of this thinking. What if we let the economy grow at 4% for an extended period of time? In reality, it will never grow at 4% for an extended period of time, because eventually consumers will get tapped out and the economy will slow down. However, let's assume we let the economy grow at 4% for an extended period of time. If the economy is growing, then that is better than if it is not growing. You don't have to be too smart to figure that out. A growing economy is good. A shrinking economy (recession) is bad.

If consumers' incomes are rising, then they will spend more and pay more in taxes. If consumers are spending more, then corporations are making profits. If corporations are making profits, then they are paying more in taxes. If they are paying more in taxes, then the deficit will come down. Do we want the deficit to come down? Apparently, no one at the Federal Reserve cares about the deficit coming down.

Look it is not that complicated. The Federal Reserve's convoluted way of thinking is that inflation is a killer and because of Jimmy Carter days, we have to get a handle on it and keep it in check. Otherwise, these Fed Governors think we will see a repeat of 18% interest rates. This is so idiotic it is not even funny. We are never going to see 18% interest rates again. That was an anomaly.

The Fed believes it is better to kill economic growth, because we cannot have 18% interest rates again. This is such a stupid way of thinking! The Fed would rather increase interest rates and thus increase our deficit.

If the economy were allowed to grow, it would reduce the deficit and burn itself back down. By that I mean, if you got a raise and bought a new house, then bought new furniture and a new car, then you are tapped out. Six months from now, you are not going to move to a new bigger house, buy more new furniture and trade in your six month old car for a new more expensive one. The Fed thinking is that yes you will do all that and they want to stop you by raising interest rates. This is stupid thinking. The economy will slow down on its own, because people will slow their spending at some point. Specifically, after they have purchased their new house, their new furniture and their new car. Mortgage rates will have to come down to attract buyers. Furniture companies will have to offer deals to get you to buy new furniture and appliances. Car dealers will have to offer incentives like lower interest rates to get you to trade in that car you bought six months ago.

Don't you see? We are never going to see 18% interest rates again. Consumers will stop it before it ever happens. Economic growth is a good thing and it will make things better for all of us. Too bad the Federal Reserve is stuck with the failed thinking of "that's the way it has always been done."

Rising Interest Rates & Its Effect on Fixed Income Investments

How long have we been listening to pundits on television tell us that interest rates are going up? One pundit on Fox Business actually said today, "you would be an idiot to buy bonds right now." This guy is the actual idiot in my opinion. He is broad brushing all of fixed income as being bad. As is true of most television pundits, he is flat out misguided.

Let's think about the possible rise in interest rates by the Federal Reserve for a moment. What is the main reason for them to raise interest rates? Historically, it has been to keep inflation in check. Well what has to happen for there to be inflation? Wages have to go up and the economy has to be expanding. My question to you is are we in the kind of economic environment where the economy is growing at a strong pace, personal incomes are rising and prices are also rising. Well, right now, only one out of three of these is happening, albeit modestly. This of course would be inflation.

In reality, we really have low inflation right now with some spikes like in energy and food. These two economic sectors are generally highly sensitive and volatile and usually spike up, then pull back. This is exactly what has happened. So, as of today, I would say that we had a short term spike in inflation, but it does not appear to be a strong upward trend.

Even assuming you believe the White House's take on the economy which I personally believe is way to optimistic, we still have horrible problems with housing and unemployment. The strength of this economy is not going to do much of anything without drastic action. The Democrats will lie and spin like they always do and the Republicans will pretend that they do not spend taxpayer dollars like drunken sailors. Both political parties are a train wreck in my opinion and the future is bleak for any meaningful change for at least until the next election.

A case in point is to look at both parties budget plans for the next 10 years. The President's plan expects to spend $27 trillion over the next 10 years. The Republicans expect to spend $26 trillion with Representative Paul Ryan's budget. In the grand scheme of things, that's not much of a difference over a ten year period.

So, when you think about interest rates rising, they typically rise faster in a strong economy. Are we there yet? Nope. High unemployment, a huge amount of housing inventory and little inflation are not the cornerstones of a scenario where interest rates are going to go up in a hurry. When they do go up, it is more likely to be a gradual increase and not necessarily a shock to the markets.

When a gradual raising of interest rates happen, it has the most effect on short term interest rates and less effect on long term rates. With a caveat, preferred stocks and high yield bonds typically pay the largest price when interest rates go up. Believe it or not, municipal bonds typically are not affected like high yield bonds are for example. The dividends tend to offset the increase in rates.

Do you really and I mean really think the Federal Reserve Bank is going to raise interest rates more than 1% any time soon? Forget about the idiot people that you see on television. Think for yourself.

Personally, I do not see interest rates going up a full 1% for probably at least one year or more. The only thing that would change my mind would be if Congress and the President eliminated the IRS, instituted a flat tax of less than 20% and lower the corporate income tax to 25%. The likelihood of all that happening in the next 12 months is slim to none. Therefore, I would not worry about interest rates going up more than 1% in the next 12 months.

Let's check back in 12 months and see if I was correct, shall we?