Joel Bowman, touching base today from Buenos Aires, Argentina...

Manic markets... turmoil in Twittlandia ... and the Midas Metal goes pop!

There was plenty to distract the patient investor this week, dear reader. But the real story centered around Jay Powell and the Fed. A headline in Barron’s summed up nicely what we’ve been writing about in these pages all year...

Stocks Dropped Because the Fed Will Keep Raising Rates Until Inflation Breaks—or the Market Does

“Higher for longer” was the message the market took from the Federal Reserve policy committee’s Wednesday decision. Officials hiked their target interest rate by 0.75 percentage point, and Chairman Jerome Powell drove home the message that there’s more work to be done.

As Bill, Dan and Tom have repeatedly told BPR readers, we’re taking a “cash now, gold later” approach. That is to say, cash while the Fed continues to raise rates (and strengthen the greenback relative to other currencies)... and gold when “something breaks” (i.e., the Fed’s backbone). 

Dan explained as much in our Powell powwow this week, which we recorded for Episode #76 of your Fatal Conceits Podcast. Here’s a snippet...

Joel Bowman: Let's start at the beginning, Dan, because we're talking on Thursday the 3rd of November and, of course the big news this week was yesterday's Federal Reserve meeting where Powell & Co. hiked rates by the expected 75 basis points, but I guess it was what followed that hike that kind of got markets a little spooked. 

We saw a 500 or so point drop in the Dow after Mr. Powell's remarks yesterday. I'm just going to read a quick quote here from the Fed Chairman in which he says "The question of when to moderate the pace of increases is much less important than the question of how high and how long to keep monetary policy restrictive." He then adding that he thought "It was very premature to discuss when the Fed might pause its increases." Was this more or less in line with what you and Tom had expected and what does it mean for both stocks and the dollar in the near term, in your view?

Dan Denning: Yeah, I think the answer to the first question is definitely. The market, whether you use the future's market for interest rate expectations or you listen to the people that are quoted in mainstream media as analysts for the major banks or Wall Street firms, at the beginning of the year, they thought that the highest the Fed would go this year was 3.75% and we've been saying since the beginning of the year that it has to be much higher than that in order to bring inflation down from 8% to even 4%. A chart that we've shown repeatedly reveals that real interest rates, so interest rates adjusted for inflation, are still negative... and they're negative by a long way. So that would change if inflation halved from here, so the Fed wouldn't have to raise as high, but we've said that people consistently underestimate how high interest rates will have to go before inflation is under control and they probably underestimate the Fed's willingness to raise them that high.

So what you get is this mistake that we saw in the summer, and again, this mistake we've seen in the fall, where the market thinks the Fed is done raising interest rates, or will pivot to either raising them less fast or even cutting them, as some people had hoped, and so they bid up the price of especially growth stocks, risk assets as they say, and everybody gets super excited because they think the end is near. But as Powell said yesterday, it doesn't appear the end is anywhere close to being near. 

He said inflation hasn't come down since last year; that there will be no pause and that the so-called terminal rate or neutral rate, is at least 5%. So all that could change if the Fed issues a press release and has another press conference, but in terms of talking to the markets about where interest rates are headed, the message couldn't have been any clearer yesterday and I just don't know why people aren't listening to the Fed, so I think that's one reason Powell spoke so forcefully.

Joel Bowman: It's a strange situation, isn't it, when we get strong inflation prints, for example, or when things in the market seem to be breaking, and investors take that as of reason to bid up stocks because they think then, “Okay, the Fed is now going to have to ease off because things are starting to break.” 

Powell said yesterday that he is going to "continue to do what needs to be done to get the job done" and by getting the job done, he explicitly mentioned bringing the rate of inflation back to around the 2% range. You've written about this before and so have both Bill and Tom, but what does that imply for a real rate? And in other words, how far does the Fed have to keep raising before it can get, as they say, ahead of the curve?

Dan Denning: Well, if you look back to the '70s in a similar situation, where I think Powell is studying his playbook, you saw that the Fed prematurely cut interest rates when inflation began to come down and then inflation came roaring back. So from that point of view, they probably want to see whatever inflation target they have, whether it's 2% or 4%, which I think... I think it's more likely they'll raise their inflation target because it'll be harder to get it to 2%, but they'll want to see it there for a while and it appears now that the only way to do that, at least according to the Fed, is to sort of crush the economy into a recession, to destroy demand at the retail level because people don't have money, which means higher unemployment, none of which are great. 

But as long as the Fed sees that there's no disorderly action in the stock market... and more importantly, I think, in the credit markets, where higher interest rates don't precipitate a bankruptcy at the corporate level – like a high profile bank or a brokerage or a really highly leveraged financial player who could then spread contagion into the rest of the market – if that doesn't happen, the Fed is happy to either continue to raise rates or, a possibility that people haven't considered, just leave them at a high rate for much longer than expected, until they see inflation figures come down.

And a lot of people say, well, if there's a ceasefire in Ukraine, then the oil price will come down and energy is a huge component of the CPI... or if X happens, then inflation will come down... but I think what Powell has made clear, and the market isn't listening, is that they're going to wait to see that number come down and stay down before they decide to sound the all clear signal. And stocks just weren't priced for that. They were priced as if interest rates were at or near their peak. And that's just clearly not the case yet.

To listen to our entire discussion, including Dan’s thoughts on the BPR Trade of the Decade, the coming Winter Catastrophe, 2022 Redux, where gold may be heading from here and plenty more, simply click on the “play” button, below...​​

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