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US Interest Rates and Inflation
INTEREST RATES AND INFLATION
What you see going on right now is just a continuation of the trend. Ben Bernanke started to taper QE in September 2013 and Janet Yellen finished it.
The Fed’s plan was:
1. Taper asset purchases
2. Raise interest rates
3. Gradually reduce the balance sheet
But the plan was all based on the idea that the US economy was getting stronger and could bear a stronger dollar. What’s happened, in fact, is that the data is coming in weak — the economy is not getting stronger.
There’s no reason to believe the Fed is not going to raise interest rates, but at the same time a strong dollar is deflationary.
They have a conundrum.
The Fed wants inflation and has a 2% target.
But they also say they want to raise interest rates.
Raising rates makes the dollar stronger which is deflationary not inflationary, because when the dollar is strong you import deflation in the form of lower import prices.
The Fed is moving away from both goals and none of it makes sense.
If they raise interest rates you’re going to see an emerging market crash — probably worse than 1997.
If they don’t raise rates, on the other hand, the market could rally because it’s the equivalent of an interest rate cut.
We’re on a knife edge between two very different outcomes.
There’s massive capital flows coming into the US from all over the world.
The way to make sense of the US bond market, stock market and currency market is that it’s a giant worldwide deflationary trait.
If Europe is cutting rates and China is easing, and the US says it’s going to raise interest rates, then global capital wants to be in the US dollar, because that’s where you’ll get a higher return.
Capital flowing into the US makes the dollar stronger and that’s deflationary.
Stocks, on the other hand, are saying, “Are you crazy? You’re going to raise rates in this weak environment? That’s going to sink the stock market.”
When is the Fed going to wake up?
Their models are wrong. Their forecasts are always wrong.
They are data dependent but the problem is that data is in real time.
In a couple of months, by June let’s say, they’ll realize that it’s a weak economy and they won’t raise rates.
But then the markets could rally, because if the markets expect a rate increase and the Fed doesn’t raise rates, then it’s like a cut.
So if they raise them there’s no bottom to the stock market. If they don’t raise them, and maybe even go to QE4, then stocks could rally.
It’s very difficult for investors because you certainly don’t want to short stocks if they don’t raise rates, but you don’t want to own them if they do.
So cash is a good component right now.
All countries are in pretty bad shape right now, but Brazil, Turkey, Indonesia, China and Mexico are all countries where capital is coming out and the currencies are going down.
Those central banks have a dilemma as well.
On the one hand they want growth, so they want to cut interest rates and weaken the currency to help exports.
But on the other hand their corporations have borrowed enormous amounts of US dollars, so if they weaken their currency it makes the US dollar stronger and they can’t pay their debts.
They either have an export train wreck or a corporate debt train wreck.
It resembles 1997. That crisis came to a head in 1998 with Russia and Long Term Capital, but it started in 1997. It can take a year or so to play out around the world.
Gold right now is a deflation trade while emerging market currencies are collapsing, bond markets are rallying and yeilds are collapsing.
Gold has gone down a little bit lately but it’s sort of holding its own.
In a highly deflationary environment with increasing real interest rates, which is what we’re seeing, Jim would have expected gold to go down to around $900 per ounce.
The fact that it’s hanging in there around the $1,100 – $1,200 per ounce level actually shows strength relative to other prices that are collapsing.
You haven’t seen the price of gold soar, but why would it in a deflationary environment?
Rising real rates are bad for gold. We’re getting rising real rates right now and gold is hanging in there.
Gold is poised to rally if the Fed “blinks” and doesn’t raise interest rates, which is what Jim is expecting.
Jim Rickards can be found on Twitter @JamesGRickards and at http://www.jamesrickardsproject.com
Gold is $1,152.20 US per ounce via Kitco.
Artists know patterns using visual and musical ratios and fractals, and everything in a closed system goes through the four seasons.
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Hold a little silver or gold and a little cash — to prepare in case of a few snowflakes.
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Wag the Dog (Drums of War and Backroom Banker Passes)
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from the album Preparing for the Fall available on iTunes
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