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FED Conundrum

Sometimes I like to be wrong in my market move expectations. Like today. I expected the market to move lower yet it moved up. It recovered almost all losses from yesterday.

I have a few long positions so it obvious that I wanted to be wrong in my expectations.

It looks like, we have experienced yet another spooky day yesterday. FED mentions a possible hike rate and investors panic. What is funny on that interest rate hike frenzy is that it didn’t happen yet, no one knows whether it happens at all and yet Wall Street is rushing to the exit. Yellen and her cohorts are just speaking about the possibility of the rate hike and it is not clear whether she will really do it at all.

Spook em
Courtesy: Stefan Cheplick’s Tumblr

So why are Wall Street freaks trembling whenever you just whisper “interest rate” words?

Those freaks out there are scared of money being more expensive would make it harder to borrow for the companies and thus slow down company’s growth.

“Higher interest rates has investors nervous about higher borrowing costs, which are negative for company profits and ultimately stocks. There’s also concern about market liquidity – how easily investors will be able to meet client redemptions if they come suddenly.” John Stoltzfus, Oppenheimer chief investment strategist

If you look at the base of the fear, considering that it really had something to do with the selloff, you must agree that Wall Street is really crazy.

What challenges are in front of FED?

Economic growth

As of now, the US economic growth is sluggish and actually slowing down. The GDP fell in three consecutive quarters and there is no sign of improving. We have seen bad reports across almost all companies out there. The only thing which makes them look good is buybacks. Consumers who were expected to spend their windfall from cheap oil did the right opposite and used the money to either pay off their debt or saved them.

The work force participation is smaller every month, jobs are mostly temporary, part time jobs. Salaries are stagnant and actually lower (inflation adjusted) than they were in 2008.

With the sluggish economic growth would raising the rates help the economy? Yellen is trying to convince us that the slowdown is seasonal and that it was caused by bad weather, too good weather, or who knows what else.

Raising the rates would slow the growth or even kill it whatsoever as the Wall Street freaks are correctly worried about. If they know it, Yellen does know it too. Would she be that stupid and raise the rates to kill the dying patient?

Enormous debt

People seem not to be talking about this item or dismiss it as irrelevant. I cannot help myself but I still am thinking about interest rates from the ordinary Joe perspective. Who typically benefit from low interest rates? Debtors or savers? Just go to the bank and open a savings account. What interest rate would you get? A miniscule 0.80% if you are lucky. Maybe 0.90%. Would you be saving happily in such environment?

And now, go and borrow that money. Unless you go to a credit card predator you may get the rate somewhere at around 15%. I was even able to obtain a personal loan at 7%. Most rates are fixed and consumer debt is expensive, but the government is mostly borrowing for what the rates are through bonds. Now, bonds are bearing some 3% or 2.5% interest. If FED raises the rates, bonds will become cheaper and their rates will go up.

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Of course, this will not impact existing bonds, but the new ones. And how is the US government managing the debt (forget now for a moment that they manage it so badly that even a total idiot wouldn’t dare doing it the same way)? They refinance the debt. As the old bond coupons are to be paid, the US government uses taxes and new debt to pay the old bonds. So they issue new bonds. That’s a luxury Greece no longer possesses. And if we act irresponsibly, we will follow the suit. Can you imagine FED raising rates to 2% by the end of 2016? Bond rates would simply go higher too and bear 5% in lieu of 3%. With $17 trillion dollars debt the US government would have to refinance at some point (they will never refinance the entire debt at once but in small increments, mostly adding new debt) at a lot higher rates and that would be very costly.

Would Yellen sink the US government into deeper debt hole? I think she won’t dare doing it.

End of recovery, political failure

There will be many people telling me that I do not understand the modern economy and that is true. I don’t. I look at the economy from a simple perspective – accounts payable and receivable. Anything beyond this is just a hocus-pocus juggling.

If we pretend to believe that we have a recovery, raising rates now would end this recovery for sure. Mostly for reasons above – more expensive money would encourage savers rather than spenders. And the US economy is based on consumer spending not saving. If consumers start spending, the inflation starts rising. And it is not happening now and it will not happen after raising the rates for sure.

I think, Yellen sees it although she will not admit it.

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Another issue is political and I believe that is one of her most important items to watch carefully. She will not dare to create collapsing market as it would look bad for the current (and any of the future) government. For six years we have been listening about great recovery from politicians and now boom. A crash. It will happen one day, but now I believe it is not politically sustainable as well as Yellen doesn’t want the market collapse (and take the economy with it) under her watch.

So, she is releasing test balloons into the economic air to see how investors, market, and or economy would react to interest rates hike. She can clearly see, that it will be nasty. Will she dare doing it and raising rates?

We will see. She may do it. I hope, I will be ready by then and not in the long positions as it seems the market will see a storm.

Are low rates good for us?

Now they are not. But I am still convinced that it wouldn’t be good for economy to raise them. Yellen can do it and risk economic turmoil and Wall Street storm. Maybe she will survive it politically, but she will do the right thing and let the economy heal itself. But she is a leftist and that doesn’t go to her agenda.

The best reason why low rates are bad were expressed by Bill Gates in the video below:


Market expectation for May 28th

The market recovered almost all losses from yesterday. Yet we are not out of the forest and we may see more selling to come tomorrow. However, today’s trading “saved the trend” and I do not expect down trend continuation. However, tomorrow we may see some selling pressure in the morning to compensate today’s bullish pressure, but at the end we will most likely end up higher. I expect the market to go UP

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