Why the Fed Will Cut Rates... And Spark a Gold Rally
Editor's note: It's time to prepare for gold to march higher...
The Federal Reserve recently approved its 10th consecutive interest-rate hike in an effort to quell today's out-of-control inflation. But with inflation still nowhere near the Fed's 2% target rate, the central bank could be tempted to shift from its aggressive inflation-fighting strategy...
According to Gold Stock Analyst editor John Doody, history shows a change in the Fed's policy could spark a major gold rally. That's why he believes it's critical for investors to begin preparing their portfolios immediately in order to capitalize on this rare opportunity.
In today's Masters Series, adapted from the May 31 issue of our free DailyWealth e-letter, John details how a Fed pivot could lead to a huge gold rally... compares today's economic turmoil with past financial crises... and reveals how investors can position themselves to profit from this setup...
Why the Fed Will Cut Rates... And Spark a Gold Rally
Federal Reserve Chairman Jerome Powell is finally hinting that he is done...
On May 3, the Fed made what could well be the final rate increase of this cycle. When the decision came out, Powell said that rates could be near a peak.
Now, it takes time for changes in Fed policy to show up in the economy... So, we believe he will wait to see the cumulative impact of the 10 rate increases that started on March 16, 2022.
This matters for a few reasons – but one is an outcome you might not expect. History shows that if this rate-hike cycle is over, it will likely spark a major gold rally... And the best gold stocks could outperform significantly.
Tomorrow, we'll explain why gold could soar. But today, we'll stick to covering the Fed's next move. As you'll see, not only is a Fed pause likely, but the conditions are in place for the central bank to start cutting rates from here.
Why are we so certain? It's simple.
Two key factors make today's economy extremely different from the one that was facing us when the Fed began its rate increases...
First, many banks are "sick." They're caught holding bonds they bought when interest rates were down around 1% and 2%. They are now suffering huge – but unrealized – losses, and we don't know how big they are.
Think of the situation like this... Bonds have a fixed annual payment (coupon), and their prices move in the opposite direction of market interest-rate changes.
A $1,000 bond bought in early 2022 that was paying $20 a year yielded 2%. It was attractive then. But now, due to the Fed's aggressive rate-hike strategy, a similar, newly issued bond has to pay 5% ($50 a year) to attract buyers. The value of the old bond must fall to $400 for it to yield the 5% needed to attract a buyer.
If the bank can hold the bond to maturity, it would get the $1,000 back, and big fluctuations in the market price of the bond wouldn't matter.
But if bank depositors start demanding their money back, the bank would be forced to sell... and realize a $600 loss.
That's what happened in the recent spate of bank failures, led by Silicon Valley Bank. Many more banks are underwater on their portfolios. All banks own bonds and make loans to earn interest to pay their expenses. Bank credit is a key support for businesses and the economy. If bond-portfolio losses have depleted banks' equity so much that they cannot lend to support business activities, the economy is in trouble.
We don't know how many banks are in this position, as they can classify the bonds as "held to maturity," making them worth $1,000 despite what Mr. Market says. Just as in 2008 to 2009, when 165 banks failed, many of these institutions may need to be saved through Fed-sponsored takeovers by larger banks... such as what JPMorgan Chase (JPM) did with First Republic Bank.
Alternatively, if the Fed lowers interest rates, it would raise bond prices... put value back into bond portfolios... and allow banks to keep lending.
That's a major incentive for the Fed to stop hiking rates today.
The second key change in our economy is the inverted yield curve. When short-term interest rates rise higher than long-term rates, it signals that a recession is on the horizon.
The short-term federal-funds rate is 5.25%, while as of Friday's close, the long-term 10-year Treasury rate was near 4%... a difference of negative 1.25%. It's a dramatically inverted yield curve. Take a look...
Since 1971, the yield curve has inverted seven times. Each was followed by a recession (shaded in the above chart, which shows this measure since 2000). The current deep inversion will yield the eighth recession.
How does the Fed react to a recession? It lowers interest rates.
Lower interest rates without lower inflation will spur gold (and the right gold stocks) higher. Right now, inflation remains over 4%, far above the Fed's 2% target. That makes gold an attractive store of value and likely to see significant gains ahead.
It's time to board the gold train to get the biggest rewards. Tomorrow, we'll explain why...
Good investing,
John Doody with Garrett Goggin
Editor's note: The next gold bull market is coming. We can't know the precise timing, but with the conditions lining up now, we think it will be soon. And the outcome is certain...
Gold prices will run higher. That's why John and Garrett recently teamed up for an online presentation to discuss how high they think gold's price could go. Plus, they revealed how investors can avoid ruining their portfolios by using the wrong way to invest in gold. Click here to watch the full replay...