Federal Reserve capitulates

February 7, 2019

Pat Heller

Thirty-seven months ago, the Federal Open Market Committee raised the federal funds interest rate from zero to one-fourth of a percent, the first rate change in seven years. It also announced that it would impose a series of interest rate hikes over the coming years.

At the time, I pointed out that continuing interest rate increases would have a negative impact on stock prices. Further, I warned that, under the pretext that the U.S. economy was improving, the Fed would keep raising interest rates until negative market reactions forced it to do a U-turn and begin cutting those rates.

That rate hike in December 2015 led to a significant fall in U.S. stock prices. Though stocks recovered and later reached record levels after President Trump’s tax cuts took effect, I continued to warn that the Fed would go too far at raising interest rates.

My projection has now come to pass. The Fed increased the interest rate last December for the ninth time and announced that it expected two additional rate increases in 2019. In response, U.S. stock prices plummeted, pushing about every U.S. stock index into negative territory for last year. It was the worst December for stocks in multiple decades.

Last week, at its regularly scheduled meeting, the Federal Open Market Committee capitulated. From its announcement at the end of the meeting, it completely removed any language projecting further rate increases. Even more, the Fed also announced that it was ending its very slow process of shrinking the Fed’s balance sheet.

Unfortunately, such a reversal by the Fed causes problems. It makes higher inflation of the U.S. money supply inevitable. It may also set the stage for the Fed to cut the federal funds interest rate at its next meeting, scheduled for March 19-20.

So, while stocks recovered after the Fed announcement last week, precious metals prices took off, and the value of the U.S. dollar tumbled. Reaction thus far this week has been muted.

From the beginning of October last year, when cracks in the Fed’s interest rate hike policy appeared, to Thursday last week (the day after the FOMC meeting), the prices of gold and silver both rose more than eleven percent! Normally financial results like that would grab media headlines, except that it is rarely reported if it happens with precious metals.

I now forecast that the dollar is destined to fall further this year while precious metals prices generally rise.