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

Negative Interest Rates: First ECB, now SNB

First the ECB lowered interest rates on deposits to -0.1% in June 2014. Now the SNB lowered interest rates on its deposits to -0.25%. Commercial bank deposits will follow soon and what would you do when you are charged for depositing money in your bank?

All of this is because the yield curves are flattening, and yields cannot be too close to each other, or we get a recession.

The effect of this drop in deposit rates should be that eventually investors remove their money from those banks and invest it in something else. Lending and spending will increase and the bubble becomes an even bigger bubble.

I do not need to tell you this is good for gold. In fact, denying the Swiss gold referendum is actually bullish for gold as the SNB can do whatever it wants now…

1) Yields go down due to lower interest rates.
2) CPI goes up through inflating the bubble.

This is why interest rates can’t be raised

Janet Yellen may be telling us that she will increase interest rates next year (and the market believes that). But here is why it can’t happen.

Because when we arrive at 2015, the long term bond yields (red and blue chart) will have almost intersected with the short term treasury bills (purple chart). We call this flattening of the yield curve.

If Janet Yellen even increases its interest rates half a percent, the 2 year treasury yields will skyrocket. The yield curves will flatten out and a recession will start, just like in 2008 where the yield curves were flat.

Note: A flattened yield curve means that all maturities (3 month, 2 year, 5 year, 10 year, 30 year bonds) have the same yield. This is typically a recessionary indicator.

Look how the 2 year bond yields go up because of Janet Yellen’s talk about increasing interest rates.

2 year U.S. bond yields

The effect of ECB negative deposit rate

The recent news about the ECB imposing a negative deposit rate in June 2014 has spurred a new trend. The deposits at the European banks is seeing outflows.

Who would want to hold deposits with negative rates? They will of course take their money out and hunt for higher yielding assets.

See what happens to the deposits of the periphery in Europe on this chart:

Why the Federal Reserve Cannot Increase Interest Rates

A very interesting chart from Mish Shedlock. You can see that the Federal Reserve can never raise interest rates as it will spike the interest payments on its debt from the current $400 billion, which can be found here, to over $1 trillion.

Interest Impact Comparison

As you know, the tax revenues are only $3 trillion at this moment. If interest payments go to $1 trillion, the interest payment as a percentage of tax revenues will go over 30%. Which is even worse than Japan’s 25% today. On top of these interest payments, we have several spending programs which will result in a total spending of more than $4 trillion. $4 trillion minus $3 trillion is a 1 trillion deficit/year at least.

This means, the Federal Reserve cannot ever increase interest rates. Especially when tax revenues will come down due to the low savings rate and high real unemployment.

Not to mention what would happen to adjustable mortgage rates and the housing market, where everyone is now using adjustable rate mortgages to profit from low rates. Knowing this, we will always have negative real interest rates as inflation will be kept at 2% and nominal interest rates at 0%. A great environment for precious metals.

Interest payments as a percentage of tax revenue: Fiscal Year 2013

As fiscal year 2013 passes by we note that the interest payments as a percentage of tax revenue has declined over the past year (Chart 1: red line). The number came in at 13% and wasn’t due to a decrease in interest payments.

Chart 1: Interest Payments

 As a matter of fact, the interest payments went up this year due to higher debt and higher interest rates (Charts 2 and 3).

Chart 2: U.S. Debt Vs. Interest Payments

Chart 3: 10 Year U.S. Bond Yield Vs. Interest Payments

The reason why we see a decline in the interest payment to tax revenue ratio is because of the huge increase in tax revenues the government received this year (Chart 4).

Chart 4: U.S. Government Tax Revenue

This was all due to a tax increase at the start of 2013 (Chart 5: blue line), which plunged the savings rate (Chart 5: red line) of households.

Chart 5: Tax Revenue Vs. Savings Rate

All in all a pretty positive year for the U.S. budget.

The question is, what can we expect from the coming year? The projected tax revenue is going to follow this trajectory according to the Federal Budget. This is more than enough to pay for the increase in interest payments due to higher public debt and higher interest rates. It will all depend on what Janet Yellen will do. If she decides to increase QE, we might see even lower interest payments due to lower interest rates.

Chart 6: Projected Revenue

Marc Faber In Thailand, Talking About Clowns

Marc Faber at a Thai studio.

Most important sentence: “The Fed has lost control of long term interest rates”. That can be seen here. Even with this money printing and expansion of the Federal Reserve’s balance sheet, they can’t keep interest rates low anymore.

But more importantly, I note that they have also lost control of short term interest rates. As you can see here, the adjustable mortgage rate is edging up, even when they hold the fed funds rate at zero. So at some point the fed funds rate needs to go up. But there is one other solution, going the other way. Let’s see if Janet Yellen is going to apply negative interest rates…

QE As Far As The Eye Can See

I don’t think we will ever see a taper again and here is why. One simple chart.

As you can see the 10 year treasury yield is now at 3% and surprisingly, this is almost as high as during the 2008 financial crisis, where the yield was 3.6%.

But there is one big difference between then and now and that is that the U.S. public debt has doubled from $9 trillion to $17 trillion.

So today we are worse off as compared to 2008. To keep yields down I don’t see any other option than QE to infinity.

There is this question on how long QE can continue to raise equity prices. Do you think this can go on till infinity?

Of course not, first off, I showed with the Potemkin anti-rally that the Dow Jones hasn’t been rising along QE. But more importantly, we need to watch what the U.S. dollar is doing.

That’s why I made this chart to show the Dow Composite Index, weighed to the U.S dollar index ( blue line). You can see the blue line has been flat lately, even though the Dow Composite went up ( green line). That’s because the U.S dollar has been going down recently (TWEXMMTH). The red line shows the expanding Fed balance sheet.

We need to keep monitoring this, because once the green and blue line diverge from each other, we’re basically going into hyperinflation mode.

Federal Reserve: To Taper or not to Taper

There is all this talk about “tapering”. Will the Federal Reserve taper or not taper, that’s the question. To find the answer, we need to take a look at the U.S. national debt.

This is really a weird sight, do we really have an actual debt ceiling? Aren’t we going to raise the debt ceiling? U.S. public debt has been growing at almost $200 billion a month and has been staying flat just recently.

Chart 1: U.S. Public Debt

Since May 19, 2013, the debt ceiling has been stuck at $16.735 trillion and this ceiling has been in place for almost 2 months as chart 1 suggests. The treasury says that they would be able to pay all the bills until October by enacting extraordinary measures from May 20 till August 2.

In all, the Treasury has the following measures available to it:

• Suspend the investments of the Thrift Savings Plan G Fund (otherwise rolled over or reinvested daily, such investments totaled $130 billion in Treasury securities as of May 31, 2013);
• Suspend investments of the Exchange Stabilization Fund (otherwise rolled over daily, such investments totaled $23 billion as of May 31, 2013);
• Suspend the issuance of new securities to the Civil Service Retirement and Disability Fund and Postal Service Retiree Health Benefits Fund (totaling an estimated $79 billion on June 30, 2013, and about $2 billion each subsequent month);
• Redeem early securities held by the Civil Service Retirement and Disability Fund and the Postal Service Retiree Health Benefits Fund equal in value to expected benefit payments (valued at about $6 billion per month);
• Suspend the issuance of new State and Local Government Series (SLGS) securities and savings bonds (between $4 billion and $17 billion in SLGS securities and less than $1 billion in savings bonds are issued each month); and
• Replace Treasury securities subject to the debt limit with debt issued by the Federal Financing Bank, which is not subject to the limit (up to $8 billion).

And due to higher tax revenues at the start of 2013, we see that interest payments on government debt weren’t a problem. In fact, the interest payments as a percentage of tax revenue has been declining since 2013 (Chart 2).

Chart 2: Interest payments as a % of tax revenue

Though, there is one parameter that was not anticipated and that is the effect of higher interest rates and higher mortgage rates.

Read the analysis here.

What is Open Interest?

BrotherJohnF explains open interest here: