Executive Summary
Last week the Federal Reserve surprised economists with a 0.50% decrease in the Federal Funds Rate, rather than the expected 0.25% decrease. There are two reasons the Fed cut rates more than expected: 1) the level of interest on the Federal debt is at crisis levels, and 2) the economy is weakening, with indicators flashing recession warnings. The second graph shows the rapid ascent of both Federal debt and the interest payments on that debt. The Fed’s main tool is to lower the FFR. Last week I shared the un-inversion of the yield curve as a recession indicator. In the last graph below, one can see the Sahm Rule Recession indicator triggered by unemployment rate increases. While it appears, the Fed sees the crisis brewing, the lawmakers do not.
Please proceed to read The Details below for more information.
“Always tell the truth. That way you don’t have to remember what you said.”
–Mark Twain
The Details
Last week the Federal Reserve surprised the consensus of economists by dropping the Federal Funds Rate (FFR) by 0.50%, instead of the expected 0.25% decrease. The two-year Treasury yield, shown in red in the graph below, is highly correlated with the FFR (shown in blue). The two-year yield has been suggesting a drop in the FFR was coming. The Fed announced expectations for further rate cuts this year and next, until the FFR drops to 2.9%.
Despite the jawboning by Fed Chair Jerome Powell that the economy is strong, the mere fact that they cut rates by 50 basis points is a clear sign of trouble ahead. There are two reasons the Fed felt compelled to cut rates more than expected: 1) the level of interest on the Federal debt is at crisis levels, and 2) the economy is weakening, with indicators flashing recession warnings.
The Federal debt balance is over $35 trillion. Annual interest on this debt has skyrocketed to over $1trillion. The fact that interest expense has more than doubled since 2020, and outside of Social Security, is the highest category of spending in the Federal budget, has the Federal Reserve scared to death. The graph below shows the spiking in interest payments (in blue), in a near vertical ascent.
The crux of the problem is the Federal debt is also rapidly climbing. The graph below from the CBO shows that debt to GDP will continue its swift ascent. As the debt balance rises, so does the amount necessary to service the debt. The Fed’s only tool is to lower rates. This is recognized as a crisis in the making, yet our lawmakers continue to turn a blind eye.
While deficits and the cost to service the debt grow, the economy is slowing. Although this has not shown up in the GDP statistics yet, other indicators are clearer. Last week I discussed the un-inverting of the yield curve as a reliable predictor of recessions. Prior to each recession since 1960, the Sahm rule, named after economist, Claudia Sahm, has been triggered. The Sahm rule is triggered when the unemployment rate increases by 0.50% from its low over the prior 12 months. The Sahm rule was last triggered in July of this year as shown in the graph below.
Between the amount of interest payments necessary to service the Federal debt and the weakening economy, now showing up in the employment data, a potential crisis is brewing. The Fed recognizes this crisis and attempted to shock the economy with a 50 basis point drop in the FFR. While they will never admit the truth behind the drop, the data is clear. The Fed is panicking and is using the main tool it has, the adjustment of short-term interest rates.
At the first sign a crisis is present, the likely response will be Fed-funded (QE) government stimulus. The problem this time is inflation. Artificially low interest rates and government stimulus will initiate a return of inflation at rates which could exceed the last bout of inflation. It appears the Fed is seeing what lawmakers are ignoring.
The S&P 500 Index closed at 5,703, up 1.4% for the week. The yield on the 10-year Treasury Note rose to 3.73%. Oil prices increased to $71 per barrel, and the national average price of gasoline according to AAA remained at $3.21 per gallon.
© 2024. This material was prepared by Bob Cremerius, CPA/PFS, of Prudent Financial, and does not necessarily represent the views of other presenting parties, nor their affiliates. This information should not be construed as investment, tax or legal advice. Past performance is not indicative of future performance. An index is unmanaged and one cannot invest directly in an index. Actual results, performance or achievements may differ materially from those expressed or implied. All information is believed to be from reliable sources; however we make no representation as to its completeness or accuracy.