Central Bankers in Shallow Water

Where the fish are bountiful and the money is easy... Central bankers in shallow water... What the Federal Reserve is most likely to do next... And what that means for the 'Melt Up'... The best system to follow Dr. Steve Sjuggerud's advice...

Former Federal Reserve Chair Paul Volcker loved fly fishing...

So back in 1982, when former Kansas City Fed President Roger Guffey invited Volcker to Jackson Hole, Wyoming – which offered some of the best fishing spots in the world – he didn't hesitate to accept the offer.

You see, Guffey wanted to spruce up his bank's annual agriculture-focused meeting, make it more prestigious, and lure more attendees. And he knew Volcker could do all of that...

Folks wanted to hear from Volcker, who had raised interest rates to historic highs of 20% just a few years earlier... The move helped end the inflation nightmare in the U.S., yet it also triggered a recession and eventually spiked unemployment to levels not seen since the Great Depression.

Volcker's speech achieved all of Guffey's goals. And with that, the central bank's annual confab was born...

Nearly 40 years later, it's still held each year near the Grand Teton mountains in Wyoming, attracting dozens of economists and other financial types... This year, it's scheduled to be held from August 26 to 28. That's less than three weeks from now.

And unlike the first event four decades ago, anyone can watch it online these days...

The overarching title of this year's event is 'Macroeconomic Policy in an Uneven Economy'...

We don't know for sure if he's into fly fishing... or if he'll be among the central bankers spending some time in shallow water... but current Fed Chair Jerome Powell will definitely be in town.

Frankly, we're glad that's the plan... If Powell weren't there per tradition, Mr. Market would likely experience a "Melt Down" simply because of the message his absence would send.

That's because the event is more significant than just the fishing (although, we admit that's debatable, depending on who you ask). This annual meeting – and the words spoken during it – is often the place where significant policy moves are announced or signaled rather clearly...

And that matters because of the "Fed watching" crowd – which, for better or worse, we're a part of. Institutional Wall Street investors will react one way or another to what all the policymakers at the Fed and elsewhere are thinking about the economy.

Stansberry NewsWire editor C. Scott Garliss explained why that's the case last week in his "macro update" for our Stansberry Portfolio Solutions subscribers...

Wall Street banks are obsessed. Not with building your wealth or protecting your assets... but with getting into the mind of the U.S. Federal Reserve in order to pad their own pockets.

Today, specifically, Scott says Wall Street is concerned about the inflation picture... and beyond that, what the Fed might do to influence it in the weeks and months ahead.

People hung on Volcker's words four decades ago...

Many folks on Wall Street and beyond will do something similar when Powell talks at the event. Whether he actually says anything meaningful or not, people will hang on his every word...

Indeed, a few weeks ago, Powell was asked in a congressional hearing about what he might say at the Wyoming retreat... He said he was working on a speech, but he declined to get into specifics. Still, something notable is bound to come out of the meeting...

Last year, for example, as we wrote in the August 27, 2020 Digest, the Fed disclosed that it would be OK with letting inflation run higher than its previously stated 2% inflation goal for an extended period of time... It was a major change in policy that dictated a lot of what happened in the economy this year.

Now, a year later, many investors are wondering if the bank will "tighten" policy... and if so, what it will look like. As we'll explain today, these questions and answers do matter... We'll also dive into what might happen – and what it could mean for your portfolio.

Scott set the stage in Portfolio Solutions last week...

The equity-market narrative is fixated on growth right now...

Money managers and traders are trying to decipher how "hot" or "cold" everything is running. Then, they can better gauge what the inflation picture looks like. If they can figure that out, they might have a better understanding of what the central bank is thinking.

The growth picture typically gives us an indication of the job environment. When growth is strong, consumers spend. If a business manufactures and sells any type of good, as the saying goes, it needs to "make hay while the sun is shining."

In other words, it wants to make sales while people are spending instead of ramping up operations as they stop spending. When demand is strong, companies hire... And when activity slows, they fire.

Central-bank policy plays an important role in that equation. As Scott explained...

"Easy money" or "loose policy" means the cost to borrow is cheap, creating easy access to cash and fueling all types of spending. That, in turn, creates economic growth. Conversely, tightening policy means the cost to borrow rises. That creates more costly access to cash, less spending, and therefore slowing growth – or even a contraction.

So as long as the growth picture remains just strong enough to undershoot the central bank's expectations, it should support easy-money policies. The longer those policies persist, the more the economy should heat up. But that can't last forever. At some point, the economy needs to stand on its own.

There are several recent developments that point to building economic momentum. These developments would push the Fed that much closer to pulling back on economic stimulus...

For one thing, the European Central Bank ('ECB') is about to offer more support to its world...

President Christine Lagarde announced new changes to the ECB's policy framework in mid-July... She said that it would let inflation run above 2% in the "medium term" – kind of like the Fed did last year.

The ECB said inflation has picked up but thinks it should be temporary... The central bank also expects to increase its bond purchases this quarter.

All of this means easy-money policies in Europe will likely remain in place longer than what Wall Street money managers and investors currently expect... The U.S. economy is ahead of Europe in terms of the COVID-19 recovery.

And more spending in that part of the world could run the risk of overheating things here in the U.S...

Just look at recent gross domestic product figures. They all point to the U.S. economy revving up...

Consumption of all types of goods continues to rebound. The demand for durable goods (nonperishable items, like cars) is now at $3.4 trillion, compared with $2.9 trillion last year. And the need for nondurable goods (quick-to-use resources, like food) jumped from $1.5 trillion a year ago to $2.1 trillion now.

If the current numbers hold, we're looking at growth of roughly 5.6% over the past two years – or about 2.8% per year.

That's above the 2.3% rate between 2010 and 2019. But it's not over the top... It's telling us that once the crazy swings of the past two years have evened out, the broader picture will move us back to where we were.

The Fed's tone continues to change...

During the final week of July, the Fed released its latest policy update...

Interest rates remain unchanged for now, and the Fed's monthly bond purchases worth $120 billion will continue. So it's not really an "update"... It's just more of the same old story.

The real news is... the U.S. economy is making progress toward its goals. A Fed watcher might expect that would mean the central bank could soon start tightening, leaving less money available in the financial system. Yet the Fed is increasing overnight access to cash.

This could be the first step in the process of dialing back or "tapering" bond purchases, according to Scott...

"Overnight" cash is intended as a means for short-term funding. A financial institution or entity sells government securities to a bank and agrees to buy them back at a later date, usually the next day (or "overnight").

There are two types of overnight actions. One is a standing repurchase facility, which provides access to cash funds. The other is a reverse repurchase facility, which pays a small rate of return to hold on to cash. In effect, repurchases are like collateralized loans used to increase reserves in the banking system, support monetary policy, and smooth market function.

That leads us into why cash matters...

Many money managers and institutions are currently taking advantage of the U.S. central bank's reverse repurchase facility. Scott discussed the details in Portfolio Solutions...

Effectively, eligible institutions store cash in the reverse facility, which pays them a small rate of return on that cash – about 0.05%. These institutions are storing around $1 trillion nightly in the facility because they don't know what to do with their cash.

In its move to increase overnight access to cash, the Fed announced the establishment of two standing repurchase facilities. By doing so, the central bank is essentially telling us that it foresees a future increase in the need for overnight dollars. These standing facilities will alleviate any future cash demands and keep overnight rates from increasing.

The first standing repurchase facility will issue short-term cash loans to eligible domestic institutions. The second will issue to eligible foreign and international monetary authorities. Both will conduct overnight operations – buying Treasury securities, agency debt securities, and agency mortgage-backed securities.

The maximum size of any overnight action will be $500 billion for each facility. In other words, the Fed could provide up to $1 trillion worth of overnight funds at any given moment. That seems like an interesting move at a time when the financial system is awash with dollars.

Typically, repurchase facilities are a way for big businesses to fund payrolls and operations. So the central bank wants to ensure ample access to money.

That's because if everyone suddenly needs overnight liquidity and supply is limited, rates will spike higher. Dealers will charge as much as they can to make a profit.

We saw this happen in the fall of 2019. Before the COVID-19 outbreak, there was a huge rush for dollars, and overnight loan rates exploded higher... In fact, they reached as high as 10% before the Fed had to step in.

By adding this availability of liquidity, the Fed hopes to avoid another rate spike. It's effectively keeping rates in check and staving off a run on the dollar...

Here's what this all means for you...

Based on these numbers, the Fed can continue biding its time instead of acting prematurely. But the metrics are starting to tell us that we're passing prior growth levels – and maybe that extra support is unnecessary...

Now, that doesn't mean interest-rate hikes are imminent... It just means that it might be time to pull back on bond purchases.

In other words, if the Fed does tighten the economy's belt at all, the central bank will probably do it one small notch at a time.

The Fed has a dual mandate from Congress to ensure full employment and stable prices. And Powell has consistently said he wants to see the economy get back to nearly full unemployment before tightening any policies... The most recent numbers show more than 10 million jobs available and roughly 8.7 million people unemployed.

So as you can see, there's still a lot of progress to be made on the jobs front.

At the same time, we're still seeing inflation, of course... And while we may not like higher prices in everything from cars and real estate to toilet paper, several of our editors agree with the Fed in the sense that this inflation will be "transitory" (temporary).

Our colleague and True Wealth editor Dr. Steve Sjuggerud is one of them...

In the most recent issue of True Wealth, published on July 16, Steve pointed out that used-car prices are up 45% over the past 12 months. That's insane, but it will likely be temporary. As Steve explained...

This situation will end... guaranteed. The problem with the supply of new cars will go away. The new-car inventory will return. And then, used car prices will fall – possibly a lot. This is simple economics.

I think the main inflation we are seeing now is more temporary (and totally separate from the long-term risk of the value of our dollar falling, which is very real)...

Today's near-term inflation is caused by COVID-induced imbalances, like we're seeing in the car market. As an example, the massive spike in used car prices in June was responsible for more than a third of the latest increase in inflation in the June numbers.

We've also had shortages of building materials, which has caused the cost of building new homes to soar. And we've had shortages of hourly labor workers... which have caused the cost of paying hourly workers to soar.

Supplies are tight. Meanwhile, demand is massive right now.

Because the Fed likewise sees inflation fears as temporary and since so many folks are still not working, it means the central bank is more likely to (or has reason to) keep the bulk of its easy-money policies – and most visibly, low interest rates – in place rather than not...

And as Steve and we have explained many times before when discussing his "Melt Up" thesis, low interest rates are among the biggest fuel sources for higher asset prices throughout the economy.

The more likely "tightening" move from the Fed, according to Scott, is reducing the amount of bonds it purchases each month (but not eliminating them entirely, either).

In other words, there's still room for the Melt Up to run...

As Steve says, today, people are thrilled to be outside and spending money once again... And that exuberance is carrying through to the investing world.

We're no doubt seeing excessive speculation in stocks, cryptos, and real estate. (Our colleague Kim Iskyan will have more on the real estate point in tomorrow's Digest.)

For now, know that everything is Melting Up... And as Steve explained in July, a Melt Down will likely follow at some point. But importantly, today's inflation won't cause it... And barring a big surprise out of the central bankers later this month in Jackson Hole, the Fed won't cause it either – yet at least.

That doesn't mean something else won't, though. We can't tell you exactly for sure what will be the ultimate trigger, but we do know the hallmarks to watch for...

What a lot of people don't understand about Steve's Melt Up research is that he and his research team have built a system that allows folks to get in and out of the markets at the perfect time based on how Steve thinks about the markets.

Their goal is for you to profit from the Melt Up on the way up while protecting yourself from the downside of the inevitable Melt Down. The key, as Steve wrote in last Thursday's Digest, is you have to have a system – and stick to it.

As Steve has written before, which we quoted in a February 2021 Digest...

This is not the time to get twitchy fingers.

We will let our computers navigate us through those bumpy waters when they arrive...

If the next correction is right around the corner, our systems will get us out to avoid heavy losses. But we don't want to let fear of a correction force us to miss out on the next leg higher.

This is a critical point to put into practice in order to make truly outsized returns when the markets are at extremes – either with fear or greed. But it's not easy.

Ten years ago, Stansberry Research gave Steve and his team $2 million to develop his dream system...

It's based on everything they've learned. And the result is a market-beating blueprint that's simple to follow...

It's a data-driven approach that helps take the emotion and guesswork out of investing. And it delivered annualized returns of 77% in 2020, one of the most volatile years in stock-market history.

As Steve said last week, this system is the culmination of his life's work. Plus, he went on camera recently to share all the details about it... as well as how to access the top three recommendations his system is pointing to right now. Click here to get started today.

A Solution for a Yield-Starved World

If you're on the hunt for massive interest yields in today's world, there's only one place to turn – cryptocurrencies. That's according to Eric Wade, the editor of our Crypto Capital and Crypto Cashflow publications.

"Since the 2008 Great Recession, central banks around the world have kept interest rates at or near zero," Wade says. Even the highest-yielding savings accounts in the U.S. barely pay any interest today. "But blockchain technology is changing the game," Eric told our editor-at-large Daniela Cambone last week...

Click here to watch this video right now. For more free video content, subscribe to our Stansberry Research YouTube channel... and don't forget to follow us on Facebook, Instagram, LinkedIn, and Twitter.

New 52-week highs (as of 8/6/21): CoreSite Realty (COR), Dropbox (DBX), Dollar General (DG), Innovative Industrial Properties (IIPR), Liberty SiriusXM Group (LSXMA), Markel (MKL), Motorola Solutions (MSI), ResMed (RMD), ProShares Ultra S&P 500 Fund (SSO), and Vanguard S&P 500 Fund (VOO).

A variety of mail in today's mailbag, including continued discussion about China... thoughts on Steve's guest essay from Thursday... and Dan's latest Friday Digest. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"I agree totally with John M. Demography is a determinant of economies which have any form of Welfare programs. Perhaps Malthus will be proven correct. Japan's demographics is leading the World. Of course, perceived existential threats can lead to reckless decisions, so in this sense China could become dangerous." – Paid-up subscriber Colin S.

"To comment on the note from Linden W... As long as what you are describing happens in China before it happens in the U.S., I'm OK with betting a little money on Chinese stocks. Between Facebook and vaccine passport tracking, we are getting pretty close to the Chinese social score system." – Paid-up subscriber Mark M.

"Steve, I do believe that markets are efficient in the sense that all information is migrating towards prices. Maybe not instantaneously and not all at once, but that migration is constant. Furthermore, the market really only runs on fundamentals, never technicals.

"The problem is that the universe of fundamentals is massive. You can never get your head around all of it. If you wanted to trade, say, corn futures based on fundamentals, then you would have to know everything that farmers, transport companies, grain traders, grain-elevator operators, fertilizer producers, heavy-equipment manufacturers, and others know. You would have to read every crop report, understand currency fluctuations, and watch out for every government manipulation. Or you can study the history of corn future prices relative to gold.

"There is also a constant confusion between 'efficient market' and 'random walk'... which are often used interchangeably when they should not be.

"Ultimately, finance and economics teach that markets are perfectly efficient and investing should be built on a buy and hold strategy of index funds using dollar-cost averaging. Why? Because that's what makes money for Wall Street. The steady supply of Main Street dollars flowing into Wall Street funds provides the liquidity and volatility that they need to both generate fees and make money on proprietary trading.

"The economists built Wall Street with their theories. They did not do that for the average person's benefit." – Paid-up subscriber M. P.

"Dear Dan, don't misread my fear as greed. It's not that I can't see the risk posed by historically high stock evaluations. It's that I can also see the risk posed by escalating inflation and taxes. Have you noticed that politicians no longer debate excessive spending – the engine that propels escalating inflation and taxes? Which risk should I fear more?

"Perhaps people continue to pile into equities because they feel the same panic that I feel." – Paid-up subscriber Rich B.

All the best,

Corey McLaughlin
Long Island, New York
August 9, 2021