What happens before the Fat Lady Sings? There’s always a dress rehearsal, or maybe two. Are we witnessing that yet? I don’t know but it’s worth pondering about, I mean the Federal Reserve is about to be forced to do what Federal Reserves do, that is to greatly reduce and even eliminate their stimulus purchases (of what amounted to $billions in government paper) in preparation for perhaps, even raising U.S. interest rates? Imagine that – yea, but the bond market is not “imagining” that at all as bond prices remain at historical highs as of this writing. Noting that the 10-year US Treasury is still hanging around 1.4%, and bond yields being inverse to their price, yields are still around historical never-before-seen lows so “Somethings Gotta Give”. I think there was a movie once with that title starring Jack Nicholson? It was a comedy, unlike this situation which will be no laughing matter looming for the U.S. bond market.

Investors are really good at following the moniker, “Don’t Fight the Fed” when the Fed Governors have a dovish stance on rates but will they listen to that famous moniker when the Federal Reserve Board does the opposite and turns hawkish on rates? Will they instead decide to hold and fight as the Fed raises interest rates? We shall see, it most likely depends on how high is high. Nonetheless, all kinds of market liquidity seems to dry up during even a “normal” tightening cycle and so prices on assets can fall rather quickly. Usually assets not backed by much but hot air get hit the hardest, early on anyway, in a Fed tightening cycle. You’ll see the low quality, speculative stuff get hit the hardest as money tends to migrate to higher quality assets, assets that can still generate cashflow will usually maintain investor confidence longer – basically those assets that are perceived to be better suited to weather a rate hike storm.

Backing the Federal Reserve into a corner and leaving them no option but to raise rates is not the best thing, but their mantra of appeasing the powers-that-be can only go on for so long before incipient inflation rears its ugly head, and that’s kind of where we are right now. The Fed must share the blame should any financial debacle take place, as they were the ones that forecasted the case for “transient” inflation. I think they made an error on presidents? My theory is this, had President Trump been re-elected then I do believe this rising inflation scenario would have been transient. One could argue this just in observing the escalating cost of fuel. With Trump at the helm the United States would have continued to expand drilling and kept all pipelines intact and open, and lastly we would have continued to be a net exporter of oil. Not so under Diaper Joe, we are now back to being an OPEC monkey.

This all leads us to speculate on how high interest rates might rise in the United States where I have both good and bad news for you. I’m not in the camp that says we’re in for a long tightening cycle, that’s the good news. If one looks at recent history examining the Obama-era economy, it is easy to draw a conclusion that a Diaper Joe U.S. economic expansion will not differ much from his mentor, Barack Obama. It will begin to look like deja-vu all over again once we settle into those very sluggish sub-2% annual growth rates. In other words, we are heading for a slowdown, even though the Republicans most likely win back control of the House, and at least maintain their split vote in the Senate in 2022. In my humble opinion these two positive factors won’t prove strong enough to overcome the continued over-regulation and over-taxation plans of the current Administration.

I’ll save my follow-on opinion on the outlook for the U.S. dollar, inflation, trade policy, and Governorship for next time. 😉