Conspiracy theorists think of the Federal Reserve Board as cabal of monocle-wearing James Bond villains that stroke Persian cats and laugh maniacally as they control the destiny of the world economy on their whims. Part of me wishes that was actually true. It would imply that someone was in control and had a plan. The Fed and its peers aren’t very good at their jobs and have no idea how to break the economy off its addiction to stimulus, as recent comments from Chairman Jerome Powell make abundantly clear.
Powell Doesn’t Know What He’s Doing
In Paris this week, Powell admitted what should have been obvious for years. Central banks really don’t know what they’re doing and are usually slow to recognize when the situation is changing.
Speaking about the response to the 2008 meltdown, Powell said that “Trend inflation, productivity and interest rates were declining well before the crisis. The threat of high inflation felt proximate for monetary policymakers in that era. The hard-fought battle to control high inflation having been just recently won.
On the eve of the greatest financial crisis in a century, the Fed and European Central Bank (ECB) were still fixated on inflation rather than on saving the world from a deflationary death spiral.
And it wasn’t just before the 2008 crisis. Years into the fallout, the ECB was stubbornly fighting non-existent inflation, even raising interest rates in April and July 2011. Just four months later, the sovereign debt crisis took another turn for the worse and the ECB had to start cutting again and eventually ending up lowering rates below zero.
The Impact of the Cut
Fast forward to today, and our Fed is set to cut rates again… at a time when the economy is at full employment and rates should be stable if not actually rising. Having inflated a massive bubble in stock and real estate prices, the Fed has painted itself into a corner. Powell is afraid to keep tightening out of fears the bubble will burst rather than gently deflate. So instead, he just inflates it further with talk of cuts. There’s really no good way out of this. Our financial markets may be addicted to stimulus forever.
This is a big deal for retirees and other income investors. If you need bond yields to rise from here in order to meet your income needs, you might be sorely disappointed. To understand what I mean, let’s take a look across the Pacific.
After peaking at above 8% at the tail end of the 1980s Japanese stock and property bubble, the country’s 10-year government bond yield proceeded to grind lower for, as of now, nearly 30 years.
The 10-year yield has now been parked at 2% or less for 22 years, and rates have been effectively zero (or even negative) since 2016.
The United States isn’t Japan.
I get that. But our Fed has been taking plays out of the Bank of Japan playbook for years, making moves that would have been taboo just a few years ago. Zero-percent interest was a taboo that couldn’t be broken… until it was. Quantitative easing, or aggressive buying of longer-term bonds, was another red line… until it wasn’t. We haven’t had negative interest rates here yet, but Japan and Europe have had them for years. Is that next?
Once certain taboos are broken, there’s no reason to assume they won’t be broken again. In fact, you’d be a fool not to assume they’ll be broken. So, at the first sight of any economic weakness, you can bet that the Fed will do whatever they have to do to push the yield curve down to effectively zero.
So, if it’s income you need, you’re not going to find it in the traditional bond market. And that’s precisely why I write Peak Income. In Peak Income, I look for high-yielding investments that are a little outside of the mainstream. In a low-yield world, I’m able to regularly find my readers dividend yields of 10% or higher.
And all you have to do is click here to learn more…