Corporate Loan Charge-Offs and Delinquencies Vs. Fed Funds Rate

Corporate loan charge-offs are bad debts on the balance sheet that will be written off and will negatively affect earnings.

Delinquencies are obligations that have missed payment beyond their due date. If these delays keep on going for too long, the corporation is declared bankrupt.

What we see below is that the Fed Funds Rate is a leading indicator for these charge-offs and delinquencies. Every time the Fed Funds Rate is increased, charge-offs and delinquencies surge with a 6 month delay.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=2S4y

As delinquencies were already surging in 2015, it will be nearly impossible for the Federal Reserve to increase interest rates in 2016. The Federal Reserve is trapped.

Alasdair Macleod explains why the Fed can’t increase interest rates

I’m just putting up this conversation of SD Metals because Alasdair Macleod is making good points on why the Fed won’t increase interest rates and will unleash QE4.

For more info on interest rates see: http://www.federalreserve.gov/econresdata/feds/2015/files/2015010pap.pdf

https://www.youtube.com/embed/xpEtgsq0dJM?feature=player_embedded

U.S. Bond Yield Curve Vs. Fed Funds Rate

There is a correlation between the yield curve and the Fed funds rate.

The yield curve plots the yield on Y-axis and maturity on X-axis. A flattening yield curve means that the yield of the different maturities are coming together and a recession starts.

On the following graph, the flattening yield curve can be witnessed by a drop to zero on the blue chart. Whenever this drop happens, a recession starts and the Federal Reserve comes to the rescue by decreasing the Fed funds rate. The problem today is that in the next recession in 2015, the Fed funds rate cannot be lowered anymore (red chart is already at 0%). The Fed is out of bullets.

//research.stlouisfed.org/fred2/graph/graph-landing.php?g=Ugt

Cool Charts at Research St. Louis Fed

The FRED site has created some cool charts with their newest update.

Now you can hover on the chart and see the exact data numbers. You can also zoom in by dragging the chart. But this will only work with Google Chrome and Firefox. Who uses Internet Explorer anyway.

Federal Funds Rate Vs. Consumer Price Index

From the first FOMC meeting lead by Janet Yellen, we noticed one important statement:

“The Fed Funds Rate will be kept low when inflation stays at this low level.”

Thus, we chart the Fed Funds Rate against the CPI and get this result.

There is a strong correlation between the Fed Funds Rate and the inflation rate (CPI).

So we expect that an increase in interest rates will only happen when inflation starts to rise. The unemployment rate is not on the radar anymore.

Notice that historically the Fed Funds Rate is higher than the inflation rate (positive real interest rate (above 0%)), but today the Fed Funds Rate is lower than the inflation rate (negative real interest rate (below 0%))

Federal Funds Rate Vs. Unemployment

The unemployment rate is a key indicator for the Federal Reserve to set the Fed Funds rate. Whenever the unemployment rate goes up, the Federal Reserve will lower interest rates. 

This can be witnessed on Chart 1 which gives the Employment-Population Ratio Vs. the Fed Funds Rate.

Chart 1: Federal Funds Rate Vs. Employment-Population Ratio

Since the economic crisis of 2008, the employment-population ratio has never really recovered, that’s why there is very little incentive to ever increase interest rates.

Be advised that we need to look at the employment-population ratio rather than looking at the unemployment rate numbers, as these numbers are subjected to hedonic measures (discouraged workers, part-time workers), which started from 2008 onwards. To show this, look at Chart 2. You will see that since 2008, the correlation didn’t apply anymore.

Indeed, the U.S. government has been manipulating the unemployment numbers since 2008 (Chart 3).

Chart 3: Unemployment Rate

Correlation: LIBOR Vs. Fed Funds Rate

The LIBOR rate at which the banks lend each other money, is an important element in calculating the gold lease rate. Obviously, this LIBOR rate is influenced by the Federal Reserve via the Fed Funds Rate.

As you can see on this chart, there is an almost 100% correlation between LIBOR and the Fed Funds Rate.

As the Federal Reserve said that they will keep interest rates at zero until 2015, LIBOR rates will keep floating around the 0% level.

This also means that the gold lease rate (LIBOR minus GOFO (Gold Forward Rate)) is entirely dependent on the GOFO rate as long as the Federal Reserve keeps interest rates near zero.

Once inflation begins to pick up though, the Federal Reserve will have to raise the Fed Funds Rate (contractionary monetary policy), which will increase LIBOR rates and this will tend to raise the gold lease rates. In turn, high gold lease rates are a bullish environment for gold prices.

Note that there is one power that will force the Federal Reserve to increase its Fed Funds Rate and that is the yields on the bond market and the mortgage market.

As you can see on this graph below, the adjustable mortgage rates are starting to edge upwards even with a zero interest rate policy. Government bond yields are also edging upwards. So eventually, the Federal Reserve will be pressured to increase interest rates to keep up with the rise in bond and mortgage yields.

Investors who are still invested in the U.S. bond market, are taking a huge risk at this stage, especially when Ben Bernanke is forced to implement contractionary monetary policies at some point. Who will buy these U.S. government bonds… As a matter of fact, foreign investors are already dumping U.S. bonds as shown in the foreign U.S. bond investors report of April 2013.

Correlation: Fed Funds Rate Vs. 10 Year Bond Yields

Another correlation Azizonomics taught me is the Fed Funds Rate Vs. 10 Year Bond Yield (Chart 1).

As long as the federal reserve keeps interest rates at zero, there is no way the 10 year bond yield will go up.

Chart 1: Fed Funds Rate Vs. 10 Year Bond Yields

If you think about this, we have 2 forces. One is debt growth (Chart 2), which is skyrocketing and the other one is the fed funds rate (Chart 1) which is at historic lows. Debt growth induces higher bond yields and low interest rates are inducing lower bond yields. I wonder which force will eventually win.

Chart 2: Public Debt Growth Vs. 10 Year Bond Yields

If the Federal Reserve even thinks about setting higher interest rates, the bond market will immediately collapse!