Why FED Rate Cuts May Crash Bonds (TLT ETF)

Bullish Bounce

19 Sept 202412:13

Summary

TLDRThe 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.

Outlines

00:00

💼 Federal Reserve's First Rate Cut and Economic Outlook

The Federal Reserve (FED) in the United States made its first rate cut of the current economic cycle, reducing the FED funds rate from 5.5% to 5%. This decision, seen as a double cut, signals the FED's serious intention to support the US economy. Despite expectations of a quarter-percent cut, the more aggressive reduction aligns with economic projections, including lower GDP growth and higher unemployment rates. The script emphasizes a comment made by Jerome Powell comparing the current economy to 2018-2019, suggesting a similar market trajectory for bonds and stocks in the coming months, with potential growth for risk assets like Bitcoin and stocks.

05:00

📉 Real Estate Inflation and Its Impact on CPI

The second paragraph focuses on the discrepancy between government-reported rental inflation and actual data from private sources like Realtor.com. While government data shows a 6% increase in rental prices, real-world data points to deflation in the rental market. This difference could drastically alter CPI (Consumer Price Index) figures, potentially bringing inflation close to negative territory. The commodities market also shows a 10% price drop over the last year, suggesting a slowdown in economic activity. This could signal weak growth or a mild recession moving forward.

10:01

🏦 Federal Reserve’s Money Management and Economic Impact

The third paragraph delves into the Federal Reserve's money management, contrasting the effects of the Fed's balance sheet reduction and its Reverse Repo facility. The Fed has deleted $1.8 trillion from the economy, while the Reverse Repo facility, which stores commercial banks' excess cash, has injected $2.1 trillion back into the system. This contradictory policy has stimulated the economy, explaining why inflation remained high in 2023. The shrinking of the Reverse Repo facility, with only $300 billion left, signals that future money deletion will reveal its true economic impact in the coming months.

Mindmap

Keywords

💡Federal Reserve

The Federal Reserve is the central bank of the United States, responsible for setting monetary policy, including interest rates. In the video, the Federal Reserve is central to the discussion, as it recently made a significant decision to cut the Federal Funds rate from 5.5% to 5%, signaling serious efforts to support the U.S. economy. The Fed’s actions are crucial for influencing economic growth, inflation, and financial markets.

💡Rate Cut

A rate cut refers to the reduction of interest rates by a central bank, in this case, the Federal Reserve lowering the Fed Funds rate by 0.5%. The video highlights this decision as an unusual double cut, emphasizing the Fed’s urgency in boosting the economy. Rate cuts typically aim to stimulate economic growth by making borrowing cheaper for consumers and businesses.

💡Fed Funds Rate

The Fed Funds Rate is the interest rate at which banks lend reserves to each other overnight. It is a critical benchmark for other interest rates in the U.S. economy. The video discusses the Fed’s recent decision to lower this rate from 5.5% to 5%, and how future cuts could influence economic conditions such as inflation and growth.

💡GDP Expectations

Gross Domestic Product (GDP) measures the total economic output of a country. In the video, the Fed’s revised projections point to slightly weaker GDP growth, suggesting a slower economic performance in the near term. GDP expectations are crucial in assessing the overall health of the economy and predicting future policy actions.

💡Unemployment Rate

The unemployment rate is the percentage of the labor force that is jobless but actively seeking employment. The video notes that the Federal Reserve expects a slightly higher unemployment rate in the coming years, which could signal economic slowdown and justify further rate cuts to boost employment.

💡CPI (Consumer Price Index)

The Consumer Price Index (CPI) measures the average change in prices paid by consumers for goods and services over time, often used as an inflation gauge. In the video, CPI inflation is described as 'plummeting,' with recent drops from 2.9% to 2.5%, and further expected declines, possibly prompting more interest rate cuts.

💡TLT ETF

TLT ETF is an exchange-traded fund that tracks the performance of long-term U.S. Treasury bonds. The video compares the performance of TLT in the context of Fed rate cuts, noting that bond prices initially surged but may face a weaker period in the next six months, similar to what happened in 2019.

💡Reverse Repo Facility

The Reverse Repo Facility is a tool used by the Federal Reserve to manage liquidity by temporarily borrowing funds from commercial banks in exchange for government securities. The video highlights how this facility has drained $2.1 trillion from the economy, countering the Fed’s inflation-fighting measures and stimulating economic activity.

💡Money Deletion

Money deletion refers to the Federal Reserve reducing the amount of money in the economy by shrinking its balance sheet, often by selling off securities. The video discusses how the Fed has deleted $1.8 trillion over the past few years as part of its efforts to combat inflation, though this effect is being mitigated by other monetary actions.

💡Commodities Price Index

The Commodities Price Index measures changes in the price of a basket of goods including crude oil, metals, and agricultural products. The video uses the GSG Index to illustrate that commodity prices have dropped, contributing to lower inflation and signaling weaker economic growth, impacting interest rate expectations.

Highlights

The Federal Reserve just made its first rate cut in this economic cycle, reducing the FED funds rate from 5.5% to 5%, signaling strong support for the US economy.

The FED implemented a double rate cut instead of the usual quarter-percent cut, indicating the seriousness of its economic support measures.

Key economic projections include weaker GDP expectations and a slightly higher unemployment rate over the next few years.

Jerome Powell mentioned that the current economy resembles the 2018-2019 period, when interest rates were also being cut.

In 2019, despite rate cuts, bond prices fell 7% while the stock market returned 16%, suggesting a possible repeat scenario in 2024-2025.

The next six months could be weak for the treasury bond market but positive for risk assets like Bitcoin and the stock market.

A 16% price gain in the S&P 500 is possible in the upcoming months, especially post-US election, based on historical patterns.

Consumer price inflation (CPI) has significantly dropped, falling from 2.9% to 2.5%, and is expected to decline further to 2.1%-2.2% in the coming months.

Private inflation data from True Inflation and real estate metrics suggest inflation could be even weaker than government reports indicate.

Real estate data points to negative rental price inflation, which contradicts the government’s 6% rental inflation figure.

Commodity prices, measured through the GSG index, have dropped by 10% over the past year, further indicating declining inflation.

The US 10-year Treasury yield is currently at 3.7%, facing opposing pressures from falling inflation and the high FED funds rate.

The FED's balance sheet has shrunk by $1.8 trillion, reducing money in circulation, yet reverse repo facilities have injected $2.1 trillion into the economy since 2022.

The reverse repo facility, which stores commercial bank excess cash, has been releasing funds into the economy, boosting inflation.

With the reverse repo facility running low on funds and continuous money deletion by the FED, the true impact on the economy will unfold over the next 12 months.