1) Since November 2015 the Fed has told us at every Fed meeting they will raise the Fed Funds rate from the current 2.15% to between 3.25% & 3.75% by December 2020, for confirmation see the Fed’s site
If the market did move to the Fed’s expectations of 3.40% it would still leave the Fed’s funds rate –3.21% below the 1968-2007 per-financial crisis average of 6.61%.
| Period | Fed Funds | 3 Month | CPI | Rate – CPI |
| Current | 2.15% | 2.25% | 2.50% | -0.25% |
| 1968-07 | 6.61% | 5.96% | 4.49% | 1.47% |
| 2008-18 | 0.75% | 0.65% | 1.83% | -1.18% |
| Pre/Post + – | -5.86% | –5.31% | -2.66% | -2.65% |
At the last Fed press conference on the 26th of September 2018 Federal Reserve Chair Powell told us,
“The US Economy is strong”
“Growth is running at a healthy clip”
“Unemployment is low”
“The number of people working is rising steadily”
“Wages are up ”
“Inflation is low and stable”
“All of these are very good signs”
It was the most glowing report by a Fed chair on the US economy in over a decade.
4:07 into the video below Fed Chair Powell once again reiterates where the Federal Reserve sees the rate they set and when.
2.15% Current
3.10% December 2019
3.40% December 2020
If the market believed the Fed it should have fueled stocks and rates hike expectation higher.
What did happen shortly after Powell’s glowing report on the US economy
The S&P 500 sold off 310.25 points from 2,913.25 to 2,603.00 by the 29th of October 2018 down -10.64%
10.7) The NASDAQ sold off 1,160.75 from 7,610.25 to 6,449.50 by the 23rd of November 2018 down -15.25%.
17 trillion in interest rate derivatives positions went from pricing in 0.6550% of the Fed’s anticipated 1.25% rate hikes by Dec 2020 to just 0.1975%.
$16,735.00, position value 4 October 2018 at 0.6550%
$4,937.50 30, November 2018, at 0.1975%
($11,413.50) Loss on this position from previous high
September through November 2018 chart Each 0.01 = $250.00
Recovery plan
I am re-entering the market
Long 15 March 2019 GEH19
Short 15 December 2020 GEZ20
Margin requirement = $5,625.00
Recommended margin = $15,000
I expect the market to price back in at least 2 of the Fed’s anticipated 4, 0.25% rate hikes between March 2019 and December 2020
$6,562.50 position value at a 17.50 entry
$20,250.00 position value at our initial objective of 0.54%
+$13,688.00 at the minimum objective of 0.5400%
If strength of rate hike exceptions remains strong I will maintain this position, if they start to weaken (as defined by the overall rate of change for the move) I will liquidate.
Maximum upside based on current Fed expectations for the rate they set
$37,500.00 position value at 1.00% (Fed expectations)
+$30,688.00 gain at the Fed’s expectations
Each 0.01 move = $375.00 USD
March 2019 Dec 2020 chart to monitor this move
I wholeheartedly believe US interest rates will rise to more normal levels but, I believe it will be fueled by deteriorating US credibility and escalating fiscal mismanagement and not economic recovery.
Interest Rate history prior to the current artificial and unsustainable lows
5.70% Average 1954 – 2007
0.07% Low July 2011
19.10% High June 1981
1953-2018 chart and monthly historical data
Powell is telling us
“The US Economy is strong”
“Growth is running at a healthy clip”
“Unemployment is low”
“The number of people working is rising steadily”
“Wages are up ”
“Inflation is low and stable”
“All of these are very good signs”
Reality using the using the numbers posted on the Fed’s and US Government websites is telling us a different story.
- Employed US population 2007-2018 is down 1.29%
- Reported Consumer Prices up 47.84%, actual prices up 68.20% to 135.60%
- 2000-2018 total Federal Revenue increased by 63.54%
- 2000 to 2018 Federal debt increased by 265.30%
- Average Treasury yield prior to “Economic Stimulus” = 6.26%
- Average Treasury Yield since “”Economic Stimulus” = 2.59%
- Each Taxpayer’s portion of the national debt, $44,069 to $142,698
- If rates normalize debt service cost would consume nearly 40% of total Federal Revenue.
| Actual Median Income | Gold Price | Income in Gold 2000-2018 |
| 2000 $41,990 | $280 | 150 ounces |
| 2018 $59,039 | $1,270 | 46 ounces |
| Increase or decrease | -69.03% |
Looking at the hard numbers it’s evident that true US inflation is running much higher than reported inflation.
This under reporting might be acceptable if median income was rising as quickly as true inflation but it’s not, Median Income from 2000 to 2018 was up a mere 0.0085% (adjusted) 40.60% (actual) while reported inflation was up 47.70% and true inflation 2000-2017 was up over 100% using pre-1990 US government calculations methods/
During “Economic Stimulus” quality of life for US citizens has deteriorated faster than any other period since the Great Depression.
Why does the BLS.GOV under report inflation?
By under reporting inflation the US Government has been able to suppress interest rates, with it debt service cost. Currently the average interest rate paid on US Government Debt is 2.52% or 3.74% below the 20 year average of 6.26% prior to “Economic Stimulus”.
Average Treasury rates prior to “Economic Stimulus” = 6.26%
Average Treasury rates since “Economic Stimulus” = 2.59%
Governmental Motivation
If inflation was being reported accurately and rates normalized it would cost the US. Government an additional 790 billion annually in debt service cost.
Should rate normalization occur, annual debt service cost would be greater than 1.3 trillion, consuming nearly 40% of all tax receipts.
Projected budget deficits would increase from 850 billion in 2018 to over 1.6 trillion.
Secondary Governmental Motivation
Currently desperate depositors looking for higher interest income to survive have been sucked into Treasuries with longer dated maturities. This has enabled the Federal Government to “fix” its debt for the longest period of time at the lowest rate on record.
As rates rise the liquidation price of these Treasuries will fall for example, if a 10 year is trading at 100.00 = liquidation value $100,000 with a yield of 3.00% should rates rise by 2.00% this Treasury will be discounted by $20,000 with its liquidation value falling from $100,000 at 3.00% to $80,000 at 5.00%. (10 year X 2.00% – $20,000)
My conclusion is the US and other countries will continue their inflation misrepresentations in an attempt to quietly monetize their debt. Their expectation is that incomes will eventually rise from inflation generating more tax revenue while at the same time the majority of Government debt is fixed greater than 6 years.
End result increased tax revenue and discounted debt.
If you have questions send a message or contact me
Regards,
Peter Knight Advisor
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