Sleight of Hand and an Election Looming
Our Market Notes reports are available to you in PDF format. Click below to download.
First, an update:
Last year, we at Consilience Asset Management added a Macro-Economic component to our Relative Capital Flow Model*. Using market action, through a process of reverse engineering, we seek to identify which macro-economic climate is being represented in the market at any given time.
This is an important addition to our discipline as central banks across the globe are attempting to unwind decades of monetary expansion. As this unwinding occurs, it could have significant ramifications for the financial market. Thus, there is an increased need to monitor this process and the corresponding macro-economic result.
Below are the ratings of securities in the five scenarios that we are monitoring:
Inflation – Neutral,
Deflation – Negative,
Stagflation – Positive,
Recovery – Positive,
Financial Crisis – Negative.
The above scenarios reflect the current Capital Flow* composite rating of the securities that have historically generated positive returns in the above economic environments.
In addition, our Global Macro Indicators* are as follows for the seven asset classes we invest in for our clients:
Global Equities – Neutral,
Global Bonds – Neutral,
Commodities – Neutral,
Gold – Neutral,
U.S. Dollar – Neutral,
Real Estate – Neutral,
Cryptocurrencies – Neutral.
Now, to this month’s report:
When it comes to the Fed, it’s easy to get hung up on what they should do, and neglect what they will do.
From an inflation perspective, it’s becoming increasingly clear the central bank needs to raise rates further to quell resurgent inflation. The risks of maintaining high interest rates or even raising them would increase government funding costs and create mounting pressure on liquidity in the financial markets.
On the other hand, cutting rates before inflation has been snuffed out threatens to intensify structural risks in the system, thus resulting in even higher inflation in the future.
Even though such a move would be unwise, it does not mean it won’t happen. And it’s an outcome made even more likely with an election looming.
In fact, the Fed has already announced that it intends to begin “tapering” by increasing bank reserves this month by reducing the monthly redemption cap on Treasury securities from $60 billion to $25 billion: (Translation: $420 Billion of new money printing over the next 12 months).
The great irony, however, is that actual inflation, according to Larry Summers and John Williams at Shadow Stats is closer to 10% rather than the current reported number of 3%.
But, as shown in previous Consilience Market Notes, and illustrated in the following chart, such a shot of increased liquidity has been very favorable for stocks. In fact, the recent rally in stocks is no doubt in anticipation of the Fed doing just that... reducing rates and printing more money!
But this reduction in the monthly redemption cap on Treasury securities means that $420 billion of debt will need to be refinanced over the next year in addition to any new debt that is required to fund our budget deficits.
In the last month’s chart on the St. Louis Fed web site, total debt was $34.1 trillion… however the most recent number from the US Treasury Department is $34,541,727,970,599.17… but by the time you read this, it’s quite possible that another few hundred billion will have taken the total to over $35 trillion!
And as I have repeatedly stated in our Market Notes, monetary expansion is inflationary. As you increase the dollars in circulation, you reduce its value. By how much?
Since the US went off the gold standard in 1971 and began running the “printing presses” without the constraint of backing a portion of each dollar with gold, the US dollar has lost over 80% of its purchasing power.
And in just the past 5 years it has declined by approximately 20%!
As shown in the following chart, the US ran a deficit of almost $1.7 trillion in fiscal year 2023…
… and is running a cumulative deficit of $1.1 trillion so far in FY2024 ($46 billion more than the same period in the prior fiscal year when adjusted for timing shifts).
According to the Bipartisan Policy Organization, revenues were $2.2 trillion through February and outlays were $3.3 trillion through March.
So, there is no indication that there is any serious effort taking place in Washington to reduce our national debt.
Does this mean that Powell’s war on inflation via rising rates ends ironically in an inflationary endgame of new money printing?
In the short run, the government reports might suggest that there has been a marked improvement in inflation.
But what if it’s merely a “sleight-of-hand” move giving the appearance of declining inflation when it is really nothing more than a temporary statistical respite because of seasonal adjustments that overstated inflation in the first quarter of the year?
If so, there will be payback later as the Fed engages in a new round of inflationary money printing before the November elections.
So, what should an investor do?
The good news is that there are asset classes that can perform favorably under multiple scenarios. Historically stocks do well when rates are declining, and money supply is expanding. Commodities and Gold have performed well when the increased money supply has resulted in inflation and Bonds have performed well during a contracting economy and declining interest rates…
Download here for more information.