EC The Fed Is Trapped In QE As Interest Rates Can’t Rise Ever Again

Since the onset of the pandemic, the Fed has entered into the most aggressive monetary campaign. Its goal was to bolster asset markets to restore confidence in the financial system. However, the trap is the Fed is in a position where they can never stop QE as interest rates can’t rise ever again.

As we discussed previously, Jeremy Siegel already declared the end to the 40-year bond bull market.

“History has shown that this liquidity has to come out somewhere, and we’re not going to get a free lunch out of this. I think ultimately, it’s going to be the bondholder that’s going to suffer. That’s certainly not the popular notion right now.” – J. Siegel via CNBC

However, this is not a new sentiment, but it has existed since I started calling for rates to fall below 1% as far back as 2013. The reasoning then, and is the same today, is the linkage between the debt and economic growth.

interest rates, The Fed Is Trapped In QE As Interest Rates Can’t Rise Ever Again.

It’s The Economy Stupid

Interest rates are a function of three primary factors: economic growth, wage growth, and inflation. The relationship between the composite index compared to the level of the 10-year Treasury rate is below.

interest rates, The Fed Is Trapped In QE As Interest Rates Can’t Rise Ever Again.

As shown, the level of interest rates correlates to the strength of economic growth and inflation. Since wage growth allows individuals to consume, which makes up roughly 70% of economic growth, the demand for borrowing is a function of the need for consumption.

But therein lies the trap – inflation.

The Fed Inflation Trap

While “deflation” is the overarching threat longer-term, the Fed is also potentially confronted by a shorter-term “inflationary” threat.

The “unlimited QE” bazooka is dependent on the Fed needing to monetize the deficit to support economic growth. However, if the goals of full employment and economic growth quickly come to fruition, the Fed will face an “inflationary surge.”

interest rates, The Fed Is Trapped In QE As Interest Rates Can’t Rise Ever Again.

Should such an outcome occur, it will push the Fed into a very tight corner. The surge in inflation will limit the ability to continue “unlimited QE” without further exacerbating inflation. Unfortunately, if they don’t “monetize” the deficit through the “QE” program, interest rates will surge as the Treasury issues more debt.

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Scott Waxler 3 months ago Contributor's comment

Interesting. Rates can never rise again? Wow. Bold statement. I guess supply and demand no longer matters in our economy.

Stock Fan 3 months ago Member's comment

Agreed.

William K. 3 months ago Member's comment

It certainly appears that the Federal Reserve bank has achieved the setting up to achieve it's hidden agenda, which appears to be the destruction of the Free Worlds economy. The unfortunate part is that there is no painless escape.

The very painful exit from the path toward a massive recession plus inflation will result in serious damage to the wealth of most of the 1%. Of course there is no reason why they should not share the pain, since they share the causation.

I realize that this comes across as total blasphemy to many, and if some wizard is able to craft a better outcome it will certainly be a welcome option.

Carl Schwartz 3 months ago Member's comment

Hidden agenda? The Fed is trying to destroy the world's economy? Isn't that a bit much? Do you think they are behind COVID-19 as well? Too conspiratorial for my taste.

William K. 3 months ago Member's comment

No, I do not think that "they" are behind the covid-19 plague. That conflagration was caused by stupidity of local government people trying to hide a problem, and the poor judgement of a whole lot of other folks shortly thereafter.

But indeed there are folks who have made it clear that they are quite offended by the fact that some nations are so much better off than other nations. And there is no estimating what avenues some of them may choose to change the picture.

Moon Kil Woong 3 months ago Contributor's comment

The treasury is falling into the same trap Japan is in faster and faster. I agree that inflation won't be a problem as much as rising unemployment and dropping demand. In reality we must deal with the simple facts pointed out by the Affluent Society by John Galbraith which was pointed out by looking at WWII. So far we haven't solved this issue yet. Rather we have chosen to bury it which will only come back to haunt us later.

William K. 3 months ago Member's comment

Certainly it is true that those who refuse to learn from seeing the mistakes of others may then be found to make the same mistakes, often with similar results. The means of solving this problem are beyond my abilities, except as applying them to my own life.