Why FED Rate Cuts May Crash Bonds (TLT ETF)

Summary

The video discusses the Federal Reserve's recent decision to cut interest rates in the U.S. by 0.5%, marking a significant shift in their monetary policy. The speaker highlights Jerome Powell's comments comparing the current economic climate to 2018-2019, predicting weak performance for the bond market and potential gains for stocks and Bitcoin. The video also touches on inflation trends, forecasting a drop in CPI, and explores how ongoing money deletion and changes in the reverse repo facility could impact interest rates and overall economic growth over the next 6 to 12 months.

Takeaways

• 📉 The Federal Reserve recently cut the interest rate from 5.5% to 5%, signaling a strong commitment to supporting the US economy.
• 📊 The Fed's decision involved a double rate cut, a more aggressive approach than the typical quarter-percent cuts, reflecting serious economic concerns.
• 📈 Jerome Powell hinted that the current economic environment resembles the 2018-2019 period when rate cuts began, possibly indicating similar market behavior in the near future.
• 📉 Historically, after the first rate cut, bond prices dropped by 7%, while the stock market surged by 16% over the following six months. This pattern may repeat until March 2024.
• 📊 Inflation is steadily declining, with CPI falling from 2.9% to 2.5%, and expectations for further drops to around 2.1% in upcoming reports, likely driving future rate cuts.
• 🏠 Rental inflation data shows discrepancies: government sources report 6% inflation, while private sources suggest deflation, which could significantly lower official CPI numbers.
• 🛢️ Commodity prices are down by 0.5% over the last year, signaling weak inflation pressures and suggesting mild economic growth or a mild recession.
• 💵 The Fed has been reducing its balance sheet by $1.8 trillion, while the reverse repo facility has injected about $2.1 trillion into the economy, contributing to sticky inflation in 2023.
• 📉 With the reverse repo facility running out of funds, the Fed's ongoing money deletion will likely have a deflationary effect on the economy over the next 12 months.
• 📈 The bond market may experience volatility as interest rates and bond prices adjust to economic realities, with potential outcomes tied to whether the US faces recession or renewed economic growth.

Q & A

What did the Federal Reserve recently do in terms of interest rates?

The Federal Reserve recently made a double rate cut, reducing the federal funds rate from 5.5% to 5%. This is notable because the Fed typically cuts rates by 0.25%, but this time it cut rates by 0.5% to signal strong support for the US economy.

How does the current economic situation resemble the period of 2018-2019?

The current economy is seen as similar to the 2018-2019 period because, back then, the Federal Reserve began cutting rates, which led to a rise in the bond market and a significant stock market rally. Jerome Powell mentioned this comparison during his speech, suggesting that a similar pattern might occur.

What is expected to happen to the bond market and risk assets in the next six months?

The bond market could weaken, while risk assets like stocks and Bitcoin are expected to perform well. This is based on historical patterns, such as the bond market falling 7% in 2019 while the stock market gained 16% during the same rate-cutting period.

How does the upcoming US election influence the stock market?

Historically, the stock market tends to be weaker leading up to US elections but often experiences strong returns afterward. This pattern suggests that the S&P 500 could see a 16% gain after the 2024 election.

What is the current trend in inflation, and what is expected in the near future?

Inflation has been dropping, with the Consumer Price Index (CPI) falling from 2.9% to 2.5%. The next CPI report, expected in October, could show inflation between 2.1% and 2.2%. This downward trend might lead the Federal Reserve to make another rate cut.

How does rental inflation differ between government and private data sources?

Government data shows rental inflation at 6%, while private sources like Realtor.com indicate negative rental inflation. This 7% discrepancy could significantly lower the official CPI figures.

What does the GSG Commodities Price Index suggest about inflation?

The GSG Commodities Price Index, which tracks a basket of goods, shows a 10% drop in commodity prices over the past year. This indicates negative inflation, supporting the idea of weak economic growth moving forward.

What role does the US 10-year Treasury yield play in determining real interest rates?

The US 10-year Treasury yield, currently at 3.7%, is influenced by inflation and the Federal Reserve's actions. While inflation is falling, the Fed's rate cuts are slower than desired, causing the 10-year yield to be caught between these two forces.

How has the Federal Reserve's reverse repo facility influenced the economy?

The reverse repo facility, which stores excess cash from commercial banks, has drained about $2.1 trillion into the economy over the past 18 months. This has effectively stimulated the economy by around $1-2 trillion, contributing to persistent inflation in 2023.

What is expected to happen to interest rates if there is weak economic growth versus stronger economic conditions in 2025?

If weak economic growth or a recession occurs in 2025, bond interest rates could drop below 3%. However, if stronger growth or higher inflation arises, such as from tax cuts or tariffs under a Trump presidency, interest rates could increase.