The Federal Reserve Bank currently finds itself between the proverbial rock and a hard place. The Central Bank believes it needs to cut interest rates because our debt-riddled economy can't function in a high-rate environment. But the Fed can't plausibly cut rates with price inflation still far above its target of 2%. The Fed's obsession with targeting a 2% inflation rate makes little or no sense, but that is a subject for a different time. Suffice it to say that most consumers, including myself, would prefer an annual inflation rate of -0- to 1%.
I can't recall a period in American economic history when monetary policies implemented by the Federal Reserve Bank were at such odds with the fiscal policies as determined by Congress. It makes no sense whatsoever. While the Fed has been taking action over the past couple of years to cram the inflation genie back into the bottle with higher rates and QT, Congress has opened the floodgates and spent money like a drunken sailor. Back in the day, sailors would come ashore after a long time at sea and go on a wild spending spree. This spend-thrift behavior was constrained by the amount of their paycheck. Unfortunately, Congress is not faced with similar limitations. The best analogy I've heard is that while the Fed is pushing hard on the brake to tighten economic conditions, Congress is pushing even harder on the accelerator to loosen conditions.
Large fiscal deficits and deficit spending are here to stay. It is past the time when federal politicians and relevant federal bureaucrats should publicly acknowledge that the current national debt of $35 trillion will never be reduced absent a default event. An explicit default is unlikely. The more likely occurrence is that the federal government will implicitly default on the debt. This will be done by creating inflation, monetizing the debt, and implementing financial repression. Please note that a future financial blog dedicated to financial repression will be forthcoming shortly from the same author who drafted this paper.
Although it remains perennially murky, cloudy, and foggy - my crystal ball provides snippets of our macro-economic future: In an era of consistently excessive federal spending, long-term bond maturities may outright reject the Fed's attempt to push down interest rates on the long end. This will throw a wrench in the machinations of the central planners. Instead of the cliche, "Don't fight the Fed," we may see "Don't fight the bond market." For now, however, we have entered an era of fiscal dominance. Debt service interest payments are approaching $1 trillion per annum and already represent 20% of federal expenditures. At current spending levels and interest rates, it won't be long before the national debt strangles the economy. At that point, the Fed will be forced to forsake its mandate of price stability and surrender to the erosive forces of inflation. At a time when it should be further raising interest rates, it will revert to artificially depressing interest rates to feed the debt monster created by irresponsible and clueless politicians.
The remainder of 2024, in particular the second half of the year, should be very interesting for the financial markets. Look for the Fed to reduce their monthly Quantitative Tightening (QT) by 50% during the summer months, followed by a cessation of QT within a couple of months after the initial 50% reduction. Wall Street and our feckless federal politicians have been clamoring for a reduction in interest rates for several months now. I believe they will get their wish a month or two before the elections in November (2024). The first rate cut and the bond market's reaction shortly thereafter will be extremely telling. Say the Federal Open Market Committee (FOMC) votes to reduce the Fed Funds rate by 25 basis points at their September 2024 meeting. Two weeks after this move, investors should check the yield on 10-year Treasury securities. Did the 10-year yields drop, stay the same, or go up? I predict the bond market will respond by bitch slapping the Fed with higher yields on the 10-year. This will be monumental and a sign to batten down the hatches.
I am disappointed in Fed Chairman, Jerome Powell. Although I prefer his leadership to his predecessor, Janet Yellen, I feel he has been remiss by remaining silent while Congress attempts to financially ruin the country. Powell contends he needs to stay in his monetary lane and not venture into expressing an opinion on fiscal policy. To a certain extent, that is admirable, but when fiscal management is so egregiously botched as we have witnessed, Powell needs to call a spade a spade and be critical of the politicians who are making it impossible for him to do his job. With the politicization of practically everything, we shouldn't be surprised the supposedly independent Federal Reserve Bank has been tainted, and it could get worse. The 4/27/24 issue of the Wall Street Journal features a page one article titled "Trump Allies Draw Up Plans to Blunt Fed's Independence." Most reasonable people would describe the prospect of Trump influencing interest rates as a horrifying thought. Do we want the "King of Debt" with a past littered with multiple business-related bankruptcies involved with this process? It would be akin to letting the Orange Fox guard the henhouse.
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