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Fed Chair Releases Dovish Trial Balloon; Says Interest Rates Are Close to “Neutral”

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Stocks rallied and the price of gold got a bounce after Federal Reserve Chair Jerome Powell released a dovish trial balloon on Wednesday.

During a speech at the Economic Club of New York, Powell seemed to indicate interest rates are “just below the broad range of estimates of the level that would be neutral for the economy.” Investors and pundits widely interpreted this to mean the central bank may well be near the end of its tightening cycle. 

Interest rates are still low by historical standards, and they remain just below the broad range of estimates of the level that would be neutral for the economy — that is, neither speeding up nor slowing down growth.”

Powell appears to have reversed position from just a month ago when he said rates were probably still a “long way” from the so-called neutral level. At that point, Powell even hinted that the Fed might tighten beyond neutral.

As you would expect, US stock markets took hints that monetary heroin might continue to flow as a positive. The Dow posted its biggest gain since March, climbing 618 points on Wednesday. The S&P 500 gained 2.3% and the NASDAQ went up 2.95%.

Gold also got a healthy boost as the dollar sagged. The price of the yellow metal was up about 0.6% on Wednesday.

Powell’s comments were just what the stock markets needed. They have been generally dropping since October with the specter of continually rising rates. Pres. Trump has repeatedly criticized Powell for pushing rates up – apparently well aware that rising interest rates in an economy built on piles of credit and debt don’t bode well and will make if difficult for him to continue to run victory laps over the “booming” economy. Just the day before Powell’s speech, Trump said he wasn’t “even a little bit happy with my selection” of Powell to head up the Fed, adding that the central bank’s tightening policy was “way off base.”

Was Powell’s suddenly dovish stance a sign that he might be cracking under the political pressure? That’s impossible to know for sure. But we do know all of the talk of an “independent Fed” is unadulterated bovine scat. The central bank is fundamentally a political institution and operates based on politics as much as economic fundamentals.

Before that speech, the Federal Reserve released a broad overview of the health of credit markets and the financial system. As you might expect, the report downplayed risk, but did highlight concerns over “elevated asset priced” (we call those bubbles) and corporate debt – an issue we addressed yesterday.

Powell characterized overall financial stability vulnerabilities as being at a “moderate level.”

Peter Schiff has predicted the Fed will eventually reverse its rate hiking policy as the economy begins to tank. Powell’s comments may well set that stage. The central bankers have to realize that rising rates were a big reason for the recent stock market selloff. They also have to see the tremors in the economy as interest rate-sensitive sectors – the housing and auto markets – are already showing signs of distress.

Just yesterday, the Commerce Department announced new home sales dropped to a more than 2-1/2-year low in October. Sales fell 8.9%. It was the lowest level since March 2016.

Powell’s may have launched his “near neutral” trial balloon hoping that will be enough to stabilize markets and get the president off his back. But Peter has said he thinks ultimately we will see real rate cuts and more quantitative easing as the central bank tries to reinflate the popping bubbles.

The economy goes into recession. Right? There’s no other result that’s possible. Real estate prices go down. Stock market goes down. Wealth evaporates. And what is the Federal Reserve going to do in response to recession? It is going to cut rates. So, regardless of the rate hikes the Fed does initially, they are simply the overture to the rate cuts. The rate hikes sow the seeds of future cuts. And investors should be looking beyond the mountain to the valley of rate cuts that are coming.”

Ultimately, rhetoric won’t stop interest rates from going up and even a pause in the Fed’s tightening policy may not do the trick. The US Treasury will have to sell billions in bonds over the coming months to cover the rapidly upward spiraling budget deficits. Simple supply and demand will likely depress bond prices and raise yields.

But for the time being, the stock market has a pacifier. It will be interesting to see how long the positivity lasts.

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