Beyond the semantics of the FOMC, an objective look at the Fed’s decision tree will be based on weak fundamental data that will continuously “kick the can down road” until there is a threat for inflation to unhinge upwards. The bottom line is the economy is not strong enough to withstand an upward trajectory of interest rates, especially Wall Street.
The facts of the matter are the following:
- Weak economic data; payrolls declining, Purchasing Managers Index (PMI) dropping, durable goods weakening, homes sales stagnating along with overall manufacturing output contracting.
- Europe near recession; China weakening rapidly; and Emerging Markets nearing credit crisis.
- Japan buying securities; China reducing interest rates and lowering reserve requirements; the ECB extending the purchasing of European government bonds (quantitative easing European style).
- Commodity dependent countries are suffering both declining revenues due to radically lower commodity prices, demand destruction as the global GDP erodes and the “threat” of higher rates in the U.S. This has also caused considerable disintermediation of investments from these countries into US dollars. The net effect of this disintermediation and “expectation” of higher USD interest rates is these countries are exporting deflation to the U.S. and the U.S. is exporting inflation to these countries.
- The continuously growth of U.S. debt. Congress has again untied the Administration’s and Washington bureaucrat’s hands from fiscal responsibility with another increase (unlimited for two years) in the debt ceiling. Higher interest rates will add to the debt spiral as Zero Interest Rate Policy (ZIRP) has held the interest on the debt to 6% of the Federal spending (approximately $230B in FYE 2015). This is a compounding problem; as both the interest rate and the overall debt increase, the total interest payments geometrically scale higher. For instance, at a 4.0% total borrowing cost (currently the total borrowing interest costs due to the Fed’s purchase of Treasury securities is only 1.2%) and total outstanding debt increasing to $20T, the annual interest payments alone would equal $800B or nearly 4x the current financing costs.
- Deflationary pressures are becoming self-evident worldwide. Deflation is a problem for the Fed with respect to their “targeted” inflation goal of 2%. Increasing interest rates, as discussed above, will only increase the value of the USD at the expense of all commodities, minerals and goods priced in dollars. Therefore, higher interest rates will directly lower the likelihood of the Fed obtaining its goal of 2% inflation, but in fact will increase the probability of further disinflation, deflation and debt pressure.
We will be looking for the Fed to wordsmith their language regarding their Zero Interest Rate Policy (ZIRP) over the next few months. Although no longer expanding their balance sheet, our research shows that the Fed’s QE (Quantitative Easing) has never really ended, while they maintain the purchasing of new treasury securities and mortgage backed securities with the maturation of their existing monstrous $4T portfolio. We remain cautious as this plays out.