Famous Last Words

It was the weather's fault... More hikes than 'previously anticipated' are coming... Buckle up... Famous last words... They're throwing darts... Be ready for more of the same...

Of course, it began with politics...

You might see some headlines about Federal Reserve Chair Jerome Powell's visit to Congress today. The two-hour-plus session began with a pair of economic-policy rants by Senate Banking Committee Chair Sherrod Brown and Ranking Member Tim Scott...

The former, a Democrat, opened by blaming the "Wall Street business model" for high inflation in the U.S. today... The latter, a Republican, then went off script from his prepared comments and said "look in the mirror," calling out the concept of "printing money."

Neither senator admitted that both sides could share blame, of course... Powell sat there silent, just watching, as the squabbling delayed his own opening statement. Meanwhile, the U.S. stock indexes were already selling off as his prepared remarks hit the internet in written form.

Here's what matters in the shorter term...

There was a lot of hot air passed around D.C. today, again. But here's the reason why the major U.S. stock indexes happened to begin a 1.5% drop precisely at 10 a.m. Eastern time, right when Powell's semiannual testimony session began...

Powell testified that January employment, consumer spending, manufacturing, and inflation data have "partly reversed the softening trends" that he'd seen in data just a month earlier. Some of this had to do with "unseasonably warm weather," Powell said (seriously). And he continued...

Still, the breadth of the reversal – along with revisions to the previous quarter – suggest that inflationary pressures are running higher than expected at the time of our previous [Federal Open Market Committee] meeting...

Although inflation has been moderating in recent months, the process of getting inflation back down to 2% has a long way to go and is likely to be bumpy... The latest economic data have come in stronger than expected, which suggests that the ultimate level of interest rates is likely to be higher than previously anticipated.

That last part is the money quote for the day...

If you've been following along with us for the past two weeks, these statements shouldn't surprise you. We've noted that the bond market – which has tended to sniff out the Fed's plans earlier than the stock market – has been expecting more rate hikes than previously thought. Powell seemed to confirm that today.

At this point, a 50-basis-point hike or 25-basis-point hike is on the table at the central bank's next policy meeting in two weeks... After Powell's testimony today, odds skewed to the latter. "Consensus" thinking was that the higher of the two options was a slim possibility just a month ago.

So you can see these expectations can change in short order based on new information and dialogue… and the Fed's next policy meeting isn’t for another two weeks. The markets will parse more data between now and then.

But for now, know that the Fed seems more "hawkish" than it was a month ago.

And about the longer term...

No matter whether the Fed's next rate hike is 50 or 25 basis points, the even bigger deal for stocks is the longer-term picture of the Fed's plan... or its "terminal" rate. Most important today, Powell's remarks previewed what we should expect...

After the next Fed meeting on March 21 and March 22, the central bank will publish its quarterly economic projections.

What I (Corey McLaughlin) heard Powell say today was that the Fed might plan on higher rates than we saw back in December, the last time it did this exercise. Presumably, that would mean higher unemployment and slower GDP growth... two other areas that the Fed publishes projections about.

So, if you're reading this today, here's a heads-up. Because as we've seen over the past year or so, the market violently reacts to these new numbers – rising or falling more than 1% in a few hours – once they're published. Until it's official, investors refuse to believe that a "higher for longer" cost-of-debt environment is still reality.

In December, the Fed projected around a 5% max federal-funds rate in 2023... and 4.6% unemployment and 0.5% real gross domestic product ("GDP") growth. I wouldn't be surprised if all those numbers are a bit worse (including higher interest rates) when the next projections come out on March 22.

Here's another important point about gauging the Fed's next moves...

Given the Fed's dual mandate of "price stability" and "maximum employment," Powell was asked when hammering the inflation part of the equation would outweigh the considerations of higher unemployment. Here's his reply...

That time could come, but it really isn't now. We're very far from our price stability mandate, and the economy is past most estimates of maximum employment...

Then there were Powell's 'famous last words'...

I nearly shut off the whole proceeding several times because it's, you know, a lawyer talking about economics to a bunch of politicians. (Apologies to the good lawyers out there.) But I'm glad I didn't...

As often happens in Powell's exchanges with politicians or reporters in Q&A formats, he let a few significant one-liners slip... I'll finish today by highlighting three of them...

Republican Sen. John Kennedy of Louisiana cited research suggesting that during the last 10 times the U.S. economy had "disinflationary periods" since the 1950s, for every 2% reduction in the inflation rate, unemployment went up by 3.6%.

Powell didn't dispute that. So Kennedy did the math...

Based on current numbers, unemployment would have to hit 7% to get the consumer price index from its current 6.4% down to 4.4%. "That's what the record would say," Powell replied.

And to get inflation down to 2.2%, based on history, Kennedy said the unemployment rate would have to go to 10.6%, right? To which Powell said...

I don't think that kind of a number is at all in play.

Write that down somewhere for posterity in the event it happens... And note that even after he agreed with the research that led to this conclusion, Powell didn't even want to think about the idea of double-digit unemployment.

Kennedy's point in bringing all this up wasn't to make a good quote. He wanted to suggest that Congress should spend less money and stop racking up debt because "the more we help on the fiscal side, the fewer people you're going to have to put out of work," he said to Powell.

"It could work out that way," the Fed chair said.

They're throwing darts...

Sometimes, given their training and how they articulate things, I think the folks at the Fed are several standard deviations smarter than me. But then I hear a plain-spoken comment – like the following from Powell today about the Fed's actual rate-hike target – and I realize they are glorified guessers.

Here was Powell talking about interest rates in general...

In theory, there's this thing called the neutral level of interest, and we know it only by its works. Neutral is the level that neither pushes the economy up nor pulls it down, and it changes over time...

Then he noted how the U.S. has had near-zero interest rates for more than a decade (and some central banks have turned rates negative)... He said the pandemic "shock" has now led to a fed-funds rate of 4.5%, low unemployment, and inflation that's only "reacting somewhat" to the Fed’s inflation-fighting stance.

And he went on...

It does raise the question of where's the neutral rate? Honestly, we don't know. We look at the current situation and we see that... it's hard to make a case that we've over-tightened. It means we need to continue to tighten.

In short, "Who knows? We'll see."

And last, but certainly not least...

The U.S. national debt came up late in the proceedings.

I'm not sure that many people were paying attention outside of those in the room in Washington, D.C. (most of the senators had already left, too). But let it be known... right around noon Eastern time on Tuesday, March 7, 2023... Powell uttered what might be our entire country's "famous last words" one day.

Wyoming Republican Cynthia Lummis asked whether Powell considers the "cost of borrowing" for the U.S. government when setting rate policy, given the size of our national debt. Congress had racked up a debt totaling around 120% of GDP as of December.

Powell said "no" and "we're not going to" consider it...

That would be fiscal dominance. If we were constrained in our monetary policy by the budgetary situation of the United States, and we're not – we're clearly not. The path we're on is not sustainable, but the level of debt that we have is sustainable. We don't think about interest costs when we make monetary policy. We think about maximum employment and price stability.

Flabbergasted, Lummis asked the natural follow-up: "It's your opinion that the level of debt we have is sustainable?" Powell said it again...

Yes. Clearly we have the largest economy in the world. We can service this debt. That's not the problem. The problem is that we're on a path where the debt is growing substantially faster than the economy. That's by definition, in the long run, unsustainable. The way countries have fixed that is with longer-term programs that have bipartisan support that address the actual problem in the budget. That's really the formula.

We're not betting on anyone "addressing the actual problem in the budget" anytime soon. So after all we heard today, the takeaway is this: Be ready for more of the same. That means more government spending, more inflation... and higher interest rates for longer and longer.

Said another way, flip the market you've known for the past 15 or 20 years on its head... the one that bubbled higher with easy money flowing all over the place. Then proceed with caution. Put your money to work in solid businesses, ideally inflation-proof ones, and avoid the weak and overleveraged outfits more likely to go bust or barely survive...

Hard assets such as real estate, gold, or commodities – that retain or grow in value as inflation sticks and as the dollar continues to lose value over the long run – have a place in a well-diversified portfolio, too... So does cash, which you can grow thanks to Uncle Sam in government-backed Treasurys, like a six-month bill whose annual yield jumped to 5.2% today.

And all that said, be on the lookout for overlooked buying opportunities. For instance, nobody wants to touch government bonds today given the uncertainty about the end of the Fed's rate-hike plans. If or when that happens, bond prices may be due for a liftoff.

But we're not there yet.

New 52-week highs (as of 3/6/23): W.W. Grainger (GWW), Ingersoll Rand (IR), and Flutter Entertainment (PDYPY).

In today's mailbag, more of your feedback on Dan's Friday essay about the Fed's latest "fairy tale"... and thoughts on a few different items in yesterday's Digest. Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"Dan's 'megalomaniacal psychopath' made me grin. But his assertion that the Fed has no supply side lever got me thinking:

"[Zero interest rate policy and negative interest rate policy] have created what Bill Bonner calls a greenhouse economy. The artificial environment of a dollar tomorrow being worth more than or equal to a dollar today has our brightest minds dedicating their time and talents to building imaginary worlds in the Metaverse and promoting virtual currency to fight inflation. Fake interest rates also promote the fraud and mismanagement so rightly decried by Dan Ferris in the Digest. The assets and talent tied up in zombie companies do not contribute to the supply side of America's economy at nearly their potential.

"The Fed can stimulate supply indirectly by removing their artificially low interest rates, and letting the zombies die. A few shovel-fulls of Chapter 7 over the zombie corpses and they'll be pushing daisies of new supply into the economy in no time. Creditors, having paid their investing 'tuition,' will fund productive AND profitable businesses instead of the visionaries' cash-bonfire companies because the imaginary profits years-down-the-road will be discounted by a positive real interest rate.

"By breaking the panes out of the greenhouse they built, the Fed may allow production and supply to thrive." – Stansberry Alliance member Paul J.

"Dan's continued ripping on the Fed is a constant necessity. For those Digest readers who haven't read it yet, The Creature from Jekyll Island by G. Edward Griffin is a must-read on the history of central banks going way back in history and leading up to America's third and current central creature..." Paid-up subscriber Gary S.

"Dan goes through a myriad of info, but the message I get is that he doesn't like the Fed, or that he doesn't like the Fed's tinkering with the U.S. economy. Well, neither do I. But rather than abolish it, (probably not possible), I think a change in policy would provide immense relief to the American people.

"Use legislation to force the Fed to change the inflation rate from 2%, to ZERO. This wouldn't solve all the Fed problems, but it would help the American people greatly." – Paid-up subscriber Frank T.

"All the places on the do not travel list [in yesterday's Digest] are mostly places we have had conflicts with, by invasion of war or sending weapons. It's no wonder why there is so much chaos around the world, especially in places we've had our dirty hands on it!" – Paid-up subscriber Chris P.

"Who would've ever thought a Mexican state bordering on the U.S. border would be considered a level four risk for the U.S. State Department?" – Paid-up subscriber Dave L.

"The derailment at East Palestine was caused by a failed brake shoe that locked the wheel and overheated the wheel set and caused a bearing failure. If the detector at Columbiana (10 miles west of East Palestine) had a hot box detector it would have alerted the train crew in time to stop the train and avoid the derailment. Unfortunately, the detector at Columbiana was only equipped to detect dragging equipment.

"Long trains do not cause derailments, but they are a real pain to the nearby community. A two-mile train going 20 mph would block a grade crossing for about six minutes. That's forever for an emergency vehicle.

"The problem is that railroads have been removing track for decades because of real estate tax. States and counties have used railroads as a cash cow. As a result, double track lines have been reduced to single track lines with passing sidings. To keep up with higher traffic loads train lengths have been increased, and with remote controlled power units this is an easy fix.

"To re-establish the double tracked infrastructure to allow shorter trains to run at higher frequency would be very expensive and I see no indication that governments have any interest in incentivizing this. They are fixated on this 'green' power ideal that can never actually work." – Paid-up subscriber Earl H.

"Maybe it's time to call all the top executives from BNSF, UP, and all the rest of the major railroads in front of Congress and ask them the hard question, 'What is going on here, and how are you going to fix it?'. These trains travel thru every small town and major city in the U.S.

"What would have happened if that hazardous train wreck that took place in Ohio was in NYC where there are millions of people? And who's to say it won't happen in the near future. This is unacceptable. Railroads are NOT policing themselves. They are just writing these disasters off as a cost of doing business at the public's demise. And just recently, Europe has another horrid train wreck. So, it's an industry-wide problem that needs a big fix." – Paid-up subscriber John M.

All the best,

Corey McLaughlin
Baltimore, Maryland
March 7, 2023