Did The Fed Indicate That They Will Be Architecting The Next Crash?

UPDATE: A day after completing this article, stock markets have plunged worldwide, and gold has risen, breaking well above key resistance levels.

Recently at the Atlantic Festival in Washington, Fed Chief Jerome Powell spoke of the “remarkably positive set of economic circumstances” grounding the economy.

Underscoring his cautiously optimistic outlook, Powell said that “there’s no reason to think it can’t continue for quite some time." Despite the most recent wage increase reports coming in well below expectations, Powell cast it in a positive light, stating that  "the Phillips curve is not dead, just resting."

Cautiously optimistic, Powell’s hawkishness remains well-poised, insisting that steady rate hikes are what’s needed as the neutral rate of interest (the point at which interest rates neither stimulate nor hold back the economy) are still far away.

But he also mentioned that the Fed may even consider going past the neutral rate of interest in the course of its tightening:

"Interest rates are still accommodative, but we’re gradually moving to a place where they’ll be neutral - - not that they’ll be restraining the economy. We may go past neutral. But we’re a long way from neutral at this point, probably.”

Did you catch the significance of that statement?

Let’s frame it in terms of what Barry Bannister, an analyst at Stifel who predicted the February correction, wrote a few weeks ago. He said that it may take just two more hikes to bring interest rates above neutral.

But it’s what Bannister said next that seems a bit foreboding:

"Although some say the neutral rate is difficult to observe, stocks see the barrier quite clearly. A ‘maximum tolerable peak’ for the fed funds above the neutral rate has been associated with bear markets since the late-90s global-debt boom."

If you remember what Powell mentioned in a keynote speech at the opening of the Jackson Hole Economic Summit just this past summer, the Fed is taking a responsively “gradualist” approach to rate hikes.

Rate hikes will continue until circumstances call for a change of strategy. This way, the Fed avoids tightening too quickly or too slowly.

But as Powell just made clear, the Fed is willing to push above the neutral rate. The thing is, that every time the Fed has done this, what has always followed was a BEAR MARKET.

This is Not Good News for President Trump

Taking a big risk, Trump has pegged the success of his presidency on the market’s upward momentum, taking credit for every new market high that has taken place since he stepped into office.

At the time of writing, the Dow Jones Industrial Average plunged by -833 points in a single day, index futures continuing to fall after hours.

Interestingly, bond markets have also declined...meaning that investors are bucking the historical trend of seeking safety in bonds.

Not surprisingly, Trump’s response is that the Fed has “gone crazy.”

But again, every Fed tightening cycle results in a market decline, making the Fed the ultimate catalyst for market crashes.

If the chart above isn’t clear enough, here are a few words from Deutsche Bank’s strategist Alan Ruskin Every Fed tightening cycle creates a meaningful crisis somewhere, often external but usually with some domestic (US) fall out. Fed tightening can be likened to the monetary authorities shaking a tree with some overripe fruit. It is usually not totally obvious what will fall out, but that there is ‘fall out’ should be no surprise. Going back in history, the 2004-6 Fed tightening looked benign but the US housing collapse set off contagion and a near collapse of the global financial system dwarfing all post-war crises. The late 1990s Fed stop-start tightening included the Asia crisis, LTCM, and Russia collapse, and when tightening resumed, the pop of the equity bubble. The early 1993-4 tightening phase included bond market turmoil and the Mexican crisis. The late 1980s tightening ushered along the S&L crisis. Greenspan’s first fumbled tightening in 1987 helped trigger Black Monday, before the Fed eased and ‘the Greenspan put’ took off in earnest. The early 80s included the LDC/Latam debt crisis and Conti Illinois collapse.

Here’s the main point. If you want to know when the next major bear market will occur, just observe how far past the “neutral rate” the Fed will go.

Just remember that they’ve announced that they will push past that rate.

One thing that is certain is that the Fed ultimately calls the major market crashes.

We just had one today. It may be a correction, or it may be much worse. Again, it’s up to the Fed.

Whatever the outcome, what you should be thinking about is whether or not you are hedged for the next bear market? Or are you just going to let the markets take away the value in your assets, stripping your hard-earned wealth?

We’re just saying...it’s a prospect that you might want to seriously consider.