The Fed Is Taking Rates Negative Soon – This is Why

Adem Tumerkan February 21, 2018
Category: Research

What I’m about to share with you is the most important thing that nobody is talking about.

I’m going to tell you why interest rates are going to go negative in the next recession. . .

I know this because of a thing called The Taylor Rule’.

The Taylor Rule is named after economist John B. Taylor – he created it – in the early 1990’s. And it is something the Federal Reserve clings to.

The rule determines how the fed gauges the economy and how they should tinker with interest rates to change inflation, employment, and economic growth.

One aspect of the rule states that for each percentage point the economy is in recession, the Fed needs to cut rates by one percentage point lower.

For example, according to the Taylor rule in 2008, the Fed should have cut rates to -2% and held them there for two years. . .

A Central Bank hadn’t cut rates into negative territory at that point – not until Europe and Japan did in 2014.

So, Ben Bernanke – then Fed Chairman – compromised and instead kept rates at 0% and launched Quantitative Easing i.e. QE – money printing – to help the economy.

Still, we can see how the Fed added extra stimulus to hold up the Taylor Rule’s stimulus principle.

Economic research shows that in a recession, the Fed needs to cut rates at least 3% to get any stimulus in the economy. . .

Not a big deal, right? They always cut rates more then 3%. In 2008 they cut rates from 5% to 0% immediately.

The problem is that the current Federal Funds Rate is only at 1.5%. . .

How can they cut rates by 3% if they’re only at 1.5% without going into negative territory?

Well, they can’t. . .

And at the Fed’s current projections, they still need 2 years until they get the Fed Funds Rate to 3%. . .

That means the Fed is in a race between time and another recession.

Which will come first in the next 2 years?

The answer: it doesn’t matter because both will happen.

I call this the ‘Fed’s Paradox’.

History shows that every time the Federal Reserve raises rates, it causes the economy to slow down or some kind of a crisis happens.

 

 

This is common sense.

As rates rise, debt burdens increase. And with American’s up to their necks in college, credit card, auto loan, and mortgage debt – a 2% increase is a lot more to pay.

Even hedge funds and investment banks suffer because they use debt – known as leverage – to buy stocks and bonds and other assets.

When rates rise, it affects everything.

That’s why over the last 30 years, as soon as the Fed raises rates for a year or two, they must eventually cut them – and even lower than they were before they started raising it – just look at the chart above.

So, by the Fed raising rates over the next two years, it will cause the very recession they fear – which will force them to cut rates even lower than 0%. . .

As an investor, you must think in probabilities.

So far the Fed has been tightening since December 2015 – it’s already been two years and they have only raised rates 1.25%.

That’s how fragile they know the economy is.

Even if they can keep raising rates, every time they do it the probability for a huge market crash or recession increases.

Thus you need to prepare for rate cuts into negative territory – because that’s what’s coming next year (2019).

Remember: It’s not like they tell you ahead of time – like I wrote above. For instance in 2008 they slashed from 5% to 0% within days.

As I wrote earlier, Europe and Japan have had rates negative and were the guinea pigs in that radical experiment.

And they’re still around. . .

Think about positioning yourself in assets that outperform during rate cuts.

Basically, anything that’s not the US Dollar.

 

 

So whats next?

For the short-to-mid-term I expect we will see the ‘smart’ money bid up the U.S. dollar – spurring a strong dollar rally. This is because of the Fed’s rising rates and Quantitative Tightening (QT) which is kicking off a global dollar shortage. And short positions unwinding from last year.

After the -13% drop for the USD in 2017 – expect a rebound throughout most of 2018.

But it won’t last for long.

Once the Fed ‘blinks’ and begins easing – the dollar will drop like a stone.

So, keep this in mind during the next 6-12 months. . .

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