The Fed 'Pause' Has Arrived

Ten rate hikes is enough, says the Fed... We'll see what happens... The 'X date' for the debt-ceiling debate... Why it could be good for bonds and gold... Taxes matter... They'll get it done... The tug of war will continue...

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The Federal Reserve is done...

Not the entity itself... but the central bank is finished raising rates for the foreseeable future after today.

This afternoon, the Fed announced it was raising its benchmark bank-lending rate by another 25 basis points to a range of 5% to 5.25%, as expected. It is the central bank's "tightest" lending rate since September 2007 ahead of the great financial crisis and double the previous rate peak of 2019.

That's what inflation, and the threat of runaway higher prices, will do to the string-pullers of the U.S. central bank... 10 rate hikes in a little more than a year.

But this appears to be the end of the road...

With cracks showing in the banking system for which it is responsible, in its carefully worded post-policy-meeting announcement today, the Fed omitted a few notable phrases that it used in the past to suggest more raises ahead...

In lieu of what we've seen over the past year-plus...

The Fed now plans to "closely monitor incoming information and assess the implications for monetary policy." And like it said in March, it will "take into account the cumulative tightening" when plotting the path forward.

In other words, Jerome Powell and Co. say they will watch what happens next with the economy before doing anything else. As the Fed chair said in a press conference today...

Our future policy actions will depend on how events unfold.

He stopped short of saying the word "pause," but everything else he said pointed in that direction. Notably, Powell said credit tightening after this spring's bank crisis is likely to slow the economy more than the Fed previously thought earlier this year.

He also didn't do anything to suggest rate cuts, or a "pivot," are on his mind, though. Powell said the other end of the Fed's dual-mandate – the job market – is still "extremely tight" with 3.5% unemployment, and that...

The process of getting inflation back down to 2% has a long way to go... [and] is likely to require a period of below-trend growth and some softening of labor-market conditions. Restoring price stability is essential to set the stage for achieving maximum employment and stable prices over the longer run.

Mr. Market seemed to accept the messaging without much concern...

The major indexes were volatile as Powell spoke, but nowhere near the level of previous Fed chair press conferences... The benchmark S&P 500 Index finished slightly down, after trading slightly higher just before the Fed announcement this afternoon.

Heading into today, bond traders were expecting the Fed to raise its federal-funds range by 25 basis points, do nothing for the next several months, and start cutting rates by the fall.

After today's announcement and Powell's press conference, those expectations remain, according to the CME Group's FedWatch Tool.

For several big reasons – including human nature and 15 years of conditioning from near-zero rates – Mr. Market can't or doesn't want to believe Powell. He's talking about pausing rates – and not cutting them – until further notice... But folks aren't listening.

If the Fed keeps its sole focus on inflation, there are risks... The bond market expects a recession in the second half of this year, and then it predicts that the Fed will start cutting rates in response. But Powell said today that he doesn't expect this scenario...

The case of avoiding a recession is in my view more likely than that of having a recession. But... I don't rule that out, either. It's possible that we will have what I hope would be a mild recession.

Of course, he could be wrong.

Among other things, there's also a big fact about self-inflicted rising interest costs on $31.4 trillion in U.S. government debt – a pressure point that still goes largely underreported. In February, the Congressional Budget Office ("CBO") projected that net interest costs would be $640 billion in 2023... and $1.4 trillion in a decade.

Surely the government can't keep this up, right? More and more spending and debt while we still have 40-year-high inflation? Well, yeah, it can if it keeps kicking the debt can down the road.

About that...

Things are starting to move in the debt-ceiling 'debate'...

Attention-grabbing headlines aside, which suggested the government will default soon, the Washington Post had a good story over the weekend that showed what the "rank and file" members of Congress are thinking about the debt-ceiling debate.

Below is a good place to jump in. Reporter Paul Kane concluded that the public posturing from the White House and Republican House leader Kevin McCarthy simply precedes the likely eventuality of an agreement that the government should spend more money...

One missing ingredient to all this bluster is an official deadline, something that will hopefully come very soon from Treasury Secretary Janet L. Yellen. Once analysts have finished the incoming and outgoing cash flows of tax season, Yellen can issue what insiders call the X date for the deadline when Treasury will run out of budget gimmicks for handling the more than $31 trillion national debt...

Congress, in this era, simply doesn't take things seriously until there's a formal deadline, so it's possible that cooler heads will prevail when countdown clocks start to appear on cable news shows.

This "X date" came on Monday, when Yellen said in a public letter to Congress that the U.S. could default on its $31.4 trillion debt as early as June 1.

Now, before you get nervous, we have seen a nearly identical version of this letter – with only the dates and other numbers changed – multiple times in the past few years. It resurfaces whenever the debt ceiling has become a mainstream talking point.

But still, this development is notable...

It means a deadline has been thrown down by the Treasury Department for when a default could happen. It also was the catalyst for President Joe Biden to say he's inviting the four congressional leaders to the White House this coming Monday to start talking...

It also means right about now is the time to expect or recognize market behavior in response to debt-default fears. As we've suggested in the past, this includes tailwinds for asset classes like gold and (counterintuitively) bonds.

As I wrote in the April 19 Digest, the last time we talked about this...

As Rob Spivey of our corporate affiliate Altimetry has shared, in the most serious debt-default worry crisis that led to a partial government shutdown in 2013, every major Treasury yield was flat or down. When the U.S. nearly defaulted, people bought Treasurys because "they wanted to be holding the most liquidly traded asset in case there was a crisis."

Of course, should the U.S. actually default, Treasurys would plummet. And "chaos hedges" like gold could soar as the U.S. dollar weakens. That could send prices of commodities higher as well and benefit emerging markets.

But absent that major event, chalk it all up as more inflation fuel. Don't expect anything different. So long as we have a fiat-currency system, dollar devaluation will always be there... and so will all of the visible and mostly hidden influences that come with it.

The fine print...

The recent letter from Janet Yellen is also significant because it shows that despite what some economists may say, taxes do matter... which is a reminder that "We the People" matter.

The CBO said earlier this week that it saw a greater risk of the U.S. running out of funds in early June, sooner than it had predicted a few months ago. As the Associated Press reported...

CBO Director Phillip L. Swagel said because of less-than-expected tax receipts this filing season and a faster IRS having processed already received returns, "Treasury's extraordinary measures will be exhausted sooner than we previously projected."

Did you catch that fine detail? A "faster IRS" – subtly giving credit to part of the upside-down-named Inflation Reduction Act legislation. The nonsense never ends...

Yet here's what I found most interesting in the Post's report, buried in the bulk of the story well below the headline. It involves folks in Congress you've probably never heard of but who appear to have at least some small dose of common sense...

A couple of dozen House Democrats have signed on to a framework with several dozen Republicans to set up a commission to recommend long-term deficit-reduction measures in exchange for raising the debt limit...

"It's certain that if we don't raise the debt ceiling our economy will crash, but if we don't do things to limit spending, our economy will also crash," said Rep. Nick LaLota, one of six New York Republicans on the Democratic target list for next year's elections. "Reasonable people should adopt that dual-pronged understanding."

"We have to negotiate. Passing a clean debt ceiling [hike] is not going to happen. He's going to have to meet us partway," Rep. Don Bacon (R-Neb.), whose district favored Biden by 6 percentage points in 2020, recently told reporters.

Republican Senator Bill Cassidy of Louisiana said that the first bill suggested by Republicans in the House last month, which we reported about, "is not the final deal, but it opens the door for a negotiated deal." According to the Post...

Cassidy noted that in past fiscal showdowns, the perceived victor tended to be the one that made the other party look most reckless.

"Partly the public perception of this is going to be really important," he said.

So, that's where we are. The bet here is that the outcome will be the same as the past 90 or so times this issue has come up since 1940, including about 20 occasions since 2001... a higher borrowing limit for Uncle Sam, consequences be damned. Invest accordingly.

There's a tug of war happening now – and likely will happen for years to come – between the inflation-fighting Fed and a freewheeling Congress spending more money. We can't change the circumstances, but we can do our best to navigate them.

Own high-quality stocks that can keep selling products or services no matter what happens next. Stay away from the garbage businesses that are least likely to survive a higher-inflation, higher interest-rate world.

New 52-week highs (as of 5/2/23): AutoZone (AZO), Franco-Nevada (FNV), McDonald's (MCD), O'Reilly Automotive (ORLY), Roper Technologies (ROP), Sprouts Farmers Market (SFM), Torex Gold Resources (TORXF), and Zimmer Biomet (ZBH).

In today's mailbag, feedback on yesterday's Digest about the Bank of England chief economist who suggested people "accept" being poorer and more about inflation and the Fed's plans... Do you have a comment or question? As always, e-mail us at feedback@stansberryresearch.com.

"After reading about Mr. Pill's comments and laughingly sharing them with my wife while we vacation in France, what leapt to mind was an equally tone-deaf comment: Let them eat cake." – Stansberry Alliance member Bob B.

Corey McLaughlin comment: C'est vrai. (It's true.)

"Corey, Obviously, Bank of England's chief economist Huw Pill has read Animal Farm by George Orwell. 'All animals are equal, some are more equal than others.' And he is at the top of the Bernie Madoff pyramid scheme.

"He is entitled to his wealth at the expense of the peasants below his social status. We just need to accept this caste system they have created.

"Of course, if [you] asked these people to take the first step they perform their best Alfred E. Neuman impersonations and look at the next person, shrug their shoulders and say 'Who, me?'!" – Paid-up subscriber Laird A.

"Hi Corey, Yes, that's all very well. But the problem is that the GOVERNMENT is not playing its part. It continues to INCREASE its spending and adds to the problem. Let them follow the same rules as the rest of us.

"Then we'll accept that we have to play our part too." – Paid-up subscriber Tim W.

"Inflation is a disease caused by politicians who are allowed by the voting public to run rampant with grandiose spending and taxing policies for decades with paper money. There is nothing controlling the politicians from just printing up more money at any whim they happen to come up with.

"Case in point: In 1934 a Ford automobile sold for $600 and change. Today the least expensive new Ford SUV sells for $27,500. That's over 4,500% higher than the Ford they sold in 1934. Put another way, in 89 years the cost of a car has inflated over 4,500%.

"And there is no end to the debt ceiling. Every year the goons in the government have a come to Jesus moment and figure out that they don't have enough money to run the government. The answer is simple, just raise the debt ceiling and print up some more money!! When will the voting public refuse to let that happen anymore?" – Paid-up subscriber John M.

McLaughlin comment: Thanks for the note, John. Yes, looking at the prices of real things in context really boggles the mind sometimes... Regarding your last question, I don't know when voters will not let it happen anymore, but it doesn't look like anytime soon.

"'These [federal-funds-rate] futures traders have put a 93% chance that by December, rates will be lower than the range the Fed will raise to tomorrow (5% to 5.25%).'

"It's Kentucky Derby week. I'm in a betting mood. For 13:1 odds, I'll take the 'not lower than 5-5.25' bet. At least it's binary [versus] fighting 19 other horses." – Paid-up subscriber Craig R.

McLaughlin comment: Riders up! On a related note, here's a question we can have some fun with: If the Fed (or any other market actor you want to think about) owned a racehorse, what would its name be?

All the best,

Corey McLaughlin
Baltimore, Maryland
May 3, 2023