Zero Interest Rates Can't Last Forever. Then Where Are We Headed?

I apologize for being so quiet this week. I am extremely busy recently so please forgive me!

Alrighty, let's get to these wacky markets.

I wanted to share some thoughts with all of you around the US dollar and the current "easy money" interest rate policy of the Fed.

Before I get into this, let me start by saying the market makes no sense right now when it comes to fundamentals (Surprise! Not!). A strong dollar is usually associated with a strong economy in most countries.

Our stock market is doing the exact opposite right now as the banks continue to buy the S&P using US taxpayer dollars.

The trend that's been working recently is short the dollar/long equities trade. Whenever the dollar strengthens (like yesterday) the trade reverses and the market tends to fall apart.

This of course makes no sense. However, should this really be a surprise when it comes to the crazy price action in our market lately?

The way I see it, the market is basically caught between a rock and a hard place as the economy continues to suffer. The only way for the banks to make money right now is in a zero interest rate environment.

This allows for them to borrow from the Fed at practically zero and then buy things like longer term Treasuries that yield 3-4%. This is a sweet spread for the pigmen.

Ironically, the pigs on Wall St have no desire to see a recovery in the short term because the profitability of the trades like the one I explained above are beautiful in their eyes. This low rate environment basically enables the banks to make sweet profits with very little risk compared to lending out money to J6P.

The current scenario described above is also having an effect on how the stock market trades:

Stocks today tend to rise as the economy continues to suffer because Wall St understands that the Fed cannot take away the punch bowl and raise interest rates as Rome burns.

As a result, traders and investors buy equities and gold based on the idea that the dollar will fall. This is the "reflation trade" that you hear about on CNBC all day.

This trade has been extremely successful recently as gold and equities have soared. Gold now sits near an all time high of over $1100 (this must make the Fed nervous). The Dow has flattened out a tad recently but still sits over 10K.

However, when the dollar reverses and rises, equities begin to sell off as the world begins to fear deflation. We saw this type of price action Wednesday as the dollar stabilized. This stabilization often occurs as a result of countries buying our dollars in an attempt to stabilize the buck in order to keep their own exports attractive.

A weaker market as a result of a stronger currency is the exact opposite of what should happen. A strong national currency usually is representative of a country that has a strong economy. This should be a boost for stocks during normal times.

As we all know, these are not normal times.

So what do you do when the market is zigging when it should be zagging after a 50+% bounce? Stay away in my opinion. I am tempted to short at these levels. In fact, I bought a few short contracts three days ago for **its and giggles.

For the most part as you all know, I continue to sit in cash and go long metals as the dollar continues to depreciate as a result of endless bailouts.

The risk of buying stocks with PE ratio's of over 100 is simply too risky for my taste.

So where are we headed?

In my opinion, I don't see why the dollar will strengthen anytime soon. As long as the fraud on Wall St continues and real price discovery continues to be ignored, the dollar is going to continue to get crushed.

The economy will not recover in such a scenario because the prices have not been allowed to "revert to the mean".

This forces buyers to sit on the sidelines thinking that prices are still too high which then kills the economy. Rising unemployment only exacerbates this problem. We now sit at a staggering 17.5% U-6 unemployment rate.

Don't forget: The real economy is dead folks. The government stimulus is the only thing keeping things afloat. Remember, the Feds would never spend like this and risk inflation/hyperinflation if they believed the economy could sustain itself.

As a result, the Fed's continued massive spending binge will dig us even deeper into trillion dollar debts. The US dollar will continue to take a beat down as a result..

Eventually this game will end because there will be no one left to borrow money from in order to keep the game going. Also keep in mind that the quantitative easing by the Fed is about to come to an end.

The Fed's Treasury purchases are just about done, and the MBS QE purchases should be completed by March in my estimate. When this buying binge ends in the spring the market is in for a VERY rude awakening.

I predict interest rates are going to soar as the world's appetite for Treasuries disappears once they realize the Fed is no longer a buyer!

Take a look at Japan if you want a preview of what happens to rates when a central bank stops QE'ing:

The Bottom Line:

As you can see above, once Japan's QE spending binge ended, rates began to rise. Are they still ridiculously low? Yes. However, Japan's famed deflation was not nearly as serious as it is usually depicted.

I expect a violent rise in interest rates next year when our QE ends. I also predict that the short dollar/long equities trade will fall apart once the dollar gets below the 72 area.

When the dollar falls to a certain level, it will be hard for the pump monkeys to continue and smoke the bull crack pipe when oil goes back up to $150 as a result of our collapsing currency.

The Fed is on a bridge to nowhere. They can't raise rates because the economy is too fragile, and the dollar will continue to fall the longer rates stay at zero. This will of course will create tremendous inflationary pressures on the economy.

Heading into early next spring I believe higher interest rates are inevitable as the various QE programs come to an end.

If the Fed ignorantly decides to extend these programs in an attempt to continue and bailout America, you better go out and buy a skateboard because it will be the only way you will be able to afford to commute to work.

Author's Disclosure: Short a couple contracts via SPY for fun. Long Gold.

Comments

[Michael Clark:]

Deflation is a 'natural' part of the process of expanding and contracting. The market gets hot money, it expands; hot money cools, the market (or economy) contracts. Our fear of deflation stems from the fact that we are a one-sided society, honoring only growth, only expansion, only development....dishono... the negative (shadow) side of this: rest, gestation, contraction, regression.

Study nature: nature acts and then rests -- and in resting, stores up energy for the next period of action. Our fear of rest is a kind of Type-A psychosis. Our fear of moving sideways (and letting inflated prices retreat) makes our deflations even worse, since one is supposed to be unwinding debt during deflations and, instead, in our mania to 'fight death' we ADD to debt during our deflations. Inflation wiped out Rome. It will wipe out America too if we don't develop a philosophy that is NOT constantly hyper-active.

The tides rise, the tides fall. Greenspan and Bernanke are cursing the tides for not always rising. This is a kind of insanity that comes from a political ideology (religion) that sees only 1/2 the world. America is in trouble politically because it distrusts philosophy and honors only activity.

The current rally is running on vapors. See report with charts below:

seekingalpha.com/insta...

Nov 13 03:07 AM

[Maxe Paul:]

Australia has strong dollar based on hard assets such as commodities and a strong banking sector.

What dose America have to justify a strong dollar?

Nov 13 04:34 AM

[Dave Wrixon:]

The dollar is not going to rise. Sure thee Fed will have to increase interest rates to reduce the rate of descent but a falling dollar and interest rates below those indicated by monetary conditions are a given. The Federal Government cannot afford to pay high interest so they are going to be kept as low a possible, and a weak dollar is goal despite the rhetoric. Lets face it if they admitted their strategy it would pancake in the morning. But when I say Low, let us not get confused. Low could still mean 10% or more. Everything is relative.

Nov 13 05:50 AM

[Faisal Humayun:]

Interest rates move in long uptrend and downtrend cycles...The interest rates in US were in an uptrend largely from 1940 to 1981....

Since then, rates have been trending downwards...In my opinion, we will see much higher interest rates then we have now...So I personally believe that the downtrend for rates is over and the next time rate go up...they will trend higher and not lower as it happened post Nasdaq bubble...

Nov 13 08:09 AM

[fwi:]

The Feds and obama can want to keep interest rates low all they want, but there is that pesky matter of ultimate market forces that government and quasi government can't wish away. At some point (I think sooner, some say later) purchasers (foreign and domestic) of our debt will demand increasingly larger rates of return. They are financial fools if they don't.

Nov 13 09:39 AM

[anarchist:]

The Fed can try and keep interest rates low but in the end the bond market will dictate the direction of interest rates.

Nov 13 10:36 AM

[Mr. Big:]

The US government and the Fed will likely take their scam as far as it can go. They are milking the system. The USD is the world's reserve currency. That means they can keep issuing debt and printing money, because they know the world will be willing to absorb the consequences (i.e. debt holders will take the hit via USD devaluation). But there's a point when the world will have to say "enough is enough" (and demand higher rates). Obviously, we're not at that point yet, since treasuries are still selling. So Tim and Ben will continue to do what they're doing until they test that point... And as each day passes, they bilk the world one more time and scores one more win for America. Sadly, this is how it's going to be....until endgame is reached. One of the key indicator for us to watch will be the treasury auctions (there will be plenty) and how successful they are. Keep an eye on the tail.

Nov 13 10:43 AM

[Moon Kil Woong:]

Thanks to the author for the warning. Real housing advancement comes on normalized rates. A housing advancement based on exorbinantly low rates is a trap more than progress. Either you run through years of Japanese style dead economy on low rates or you see collapse too when the yield curve normalizes. Both are bad, but the first is catastrophic, because it kills not just housing but to the whole economy for years if not decades.

Nov 13 11:44 AM

[Madcow2:]

The Fed has 2 choices:

A: Admit that debt-based money is a doomed pyramid scheme and allow the US economy to suffer a deflationary collapse.

or

B: Continue to insist that perpetual motion machines are viable and precipitate hyper-inflation.

*

My sense is "B." These people are going to do absolutely everything in their power - legally and illegally - to avoid having to admit they are wrong.

Nov 13 01:42 PM

[Tony Daltorio:]

I strongly believe the Fed will continue to print money (QE) and support the Wall Street banksters until everyone finally loses faith in the country and the US dollar and it collapses toward its true value near zero.

Who will suffer the most? The average American...not the Banksters. They will have all of their assets in other countries, other currencies, and precious metals & other commodities.

Nov 13 03:30 PM

[yousef saleh:]

OK, I'm sick of people saying "why did buffet do this" & "why did buffet do that". People, Warren Buffet is a BILLIONAIRE. He makes deals worth BILLIONS. When you want to buy a billion dollars worth of stock from a company, the SEC will interfere, this is no spot transaction.

Do you think a deal to buy a whole company is done in 2 days or a week or even a month? These things take months and sometimes years to make and they are in no where related to the spot value you see today of the Dow or the SP500.


On Nov 13 11:08 AM PARTICULARMEN wrote:

> Warren Buffett: The financial panic is over (Reuters headline)<br/>
>
> Why Warren Buffett pays $34 billion (market cap) for BNI instead
> max. $24 billion when market DJIA was at 6500?
> Why BRK depends on Goldman Sachs bankers?
> Why Buffett is buying stuff at the peak of the market instead of
> waiting to buy cheaper in a very short time ?
> Does he think DJIA at 10000 is "cheap" ?
> Why he wanna split his highly priced BRK.B shares and make it appeal
> to average John Q. Public investor ?
> He buys BNI at the top to calm the matket panic and "make you buy
> too".
> Why BRK is not selling all their stuff, when W. Buffett knows very
> clear that DJIA will be 5000 soon and will bottom only at 2000 that
> will hit him too?
> Find out in WARREN BUFFET? link
> snipr.com/t7w23

Nov 13 04:14 PM

[been there:]

interest rates determine prices of houses since people only look at per month payments. a $100,000 house @ 4% will only have a market price of $50,000 @ 8%. so people buying now can look forward to selling a house 50% under water when the rates double good luck.

Nov 13 08:06 PM

[twotraps:]

Agree with much of the article comments here. It will be interesting to see the mkt reaction to slightly, just slightly less demand at the auctions. Rates can move higher without the fed's blessing, perhaps without the violence that we saw a year ago.....but the game will be on. Is it just me or is the govt. insuring more than it can possibly ever handle? When that backstop is seen as worthless, it will speed the next move, fueling higher rates.

Nov 14 07:34 AM

[Tack:]

Of course, at some point, rates will rise. The unspoken implication in much of that discussion is that the economy and market must tank. However, the economy, markets and housing have thrived in previous periods when interest rates were 7,8 even 9%, so it's not clear that any minor rise in rates should have any catastrophic impact on economic matters.

What plagues the economy now, much more than any cost issues, is a failure of confidence. Restore confidence, and, within reason, rates won't matter.

Nov 14 08:12 AM

[Wildebeest:]

On Nov 14 08:12 AM Tack wrote:

>
> What plagues the economy now, much more than any cost issues, is
> a failure of confidence. Restore confidence, and, within reason,
> rates won't matter.

Restoring confidence is probably one of the things these idiots thought would occur if they reinflated equities (success) and housing (failure). Joe Sixpack has seen through this fraud because the stimulus has been used to finance speculation rather than finance getting main street on its feet. Why Bernanke and Geitner still have jobs is one of lifes puzzles.

Nov 14 09:31 AM

[User 330841:]

Remember.................
Economists are not realists.................

Nov 14 09:54 AM

[Dieter Hohe...:]

They are getting a return in Asia. The trade surplus they have with us is completely rigged and not based at all on "free trade." They want that to continue as long as we are stupid enough to permit it. We have transferred trillions in wealth and technology to Asia since the 1960s and the American Bilderbergers want that to continue as a balkanized and enervated America will more easily accept rule by the UN. Sure it is conspiratorial... it is also veracious.


On Nov 13 09:39 AM fwi wrote:

> The Feds and obama can want to keep interest rates low all they want,
> but there is that pesky matter of ultimate market forces that government
> and quasi government can't wish away. At some point (I think sooner,
> some say later) purchasers (foreign and domestic) of our debt will
> demand increasingly larger rates of return. They are financial fools
> if they don't.

Nov 14 05:32 PM

[wackyfunster:]

One interesting thing about supply-demand considerations in real estate is that, in a market that is not inordinately inflated by artificially generated demand via low interest rates, there is substantial competition between home-buyers and investors. I find it interesting that, despite living in one of the hardest hit cities in TX in terms of foreclosures (San Antonio), housing prices have not declined substantially, as one can still very easily rent a house purchased at market value and at least break even, thanks to current interest rates. I would be interested in seeing an analysis of decline in property value in relation to the ratio of mortgage payments to median rental prices, as this seems to be a factor that is rarely considered. I'm also very interested in any thoughts that those more informed than I may have on the effect that dollar weakness and a "jobless recovery" may have on the traditional relationship between rental prices and inflation... if anyone can point me to some useful information I would be much obliged.

Nov 15 01:57 AM

[manya05:]

People seem to forget that "zero" is a discontinuity. 0% interest rates suspend all sort of logical things from happening. For instance, if you are making 0% on your cash, then a dividend from a company, any dividend, looks like a good proposition. So, it does not matter if the S&P P/E is 10, 20, 100, or a million, a dividend is better than zero. Likewise with borrowing at 0% interest. If you can borrow for free, maybe some crazy investments (like opening a chain of pedicure stores for pigs, or buying US government debt paper) may seem like a viable idea. If you had to pay to borrow the money, you will probably would probably think twice before taking the risk.

So, do not forget that a 0% interest rate world is one in which logic is suspended, so do not try to make sense of it. Now, as soon as finite interest rates are reintroduced, then yes, watch for the following:

- Higher mortgage rates and the housing market grinding to a screeching halt
- A big tumble in stock markets worldwide as P/E will matter again
- A sudden (and artificial) appreciation in the dollar as all sorts of carry trade transactions are unwound

This process will manifest itself in two steps. Initially, at the first intonation from the Fed that interest rates will go up, and then on a second leg the days before the Fed meeting when interest rates are actually raised (and the information is leaked so the usual suspects can enrich themselves from the information one more time, and then pass their "cut" to the appropriate Fed officials).

Nov 15 10:26 AM

[untrusting ...:]

Ok, so what's going to happen then if inflation/price increases hits 5-10+% in the US? If the dollar keeps falling and interest rates stay at ultra low levels, then sooner or later exporters to the US are going to demand much higher prices for goods they ship to the US. They will not continue to accept 10-20-30% lessor prices in US dollars for their exports to the US. What's going to happen to US costs of manufacture and services when/if oil goes over $100/barrel. US producers will not be able to absorb much higher input and energy prices without susbtantially rising their selling prices? And finally where and what US consumers are going to be able to pay higher inflated prices?

A continuation of dollar devaluation and ultra low interest rates ultimately will morph into a titanitc disaster for the average US consumer. And as the US consumer goes, so goes the federal-state-local governments. All levels of government are already in plenty of trouble regarding fiscal matters. As the US consumer is dragged down, the governments will be dragged into more and more fiscal difficulty, which will lead to a self-fulfilling downward spiral.

You state that the government cannot afford to pay higher interest rates. Can they alternatively afford to watch the destruction of the US consumer, taxpayer, and government at all levels which result from artifical low interest rates and the corresponding destruction of the dollar and the resulting higher prices that are almost certain to follow? Basically a few hundred billion in extra interest payments are trival in comparison to say a 10% price increase in a $14 trillion economy and the resulting destruction from that.


On Nov 13 05:50 AM Dave Wrixon wrote:

> The dollar is not going to rise. Sure thee Fed will have to increase
> interest rates to reduce the rate of descent but a falling dollar
> and interest rates below those indicated by monetary conditions are
> a given. The Federal Government cannot afford to pay high interest
> so they are going to be kept as low a possible, and a weak dollar
> is goal despite the rhetoric. Lets face it if they admitted their
> strategy it would pancake in the morning. But when I say Low, let
> us not get confused. Low could still mean 10% or more. Everything
> is relative.

Nov 15 01:24 PM

[untrusting ...:]

Could not agree more with your comment. Joe Sixpack can clearly see that Bernanke, Geitner, and the politicans have engaged yet again in policies that have restored wealth to oligarchs, wall street, and the wealthiest minority. But at the same time conditons for Joe Sixpack from credit availability, to interest rates, to employment, to taxes, to retirement, to future prices, etc. continue to deteoriate.

The system continues .... the military-industrial-wa... complex continues to game the average American and grab ever larger shares of American wealth. For anyone who saw Frontline-The Warning, which details the financial sheninigans of Greenspan, Summers, Geithner and the US banking cartels in the late 1990's fiasco over derivative regulation ... one has to wonder how Summers, Geithner, and others are not in jail much less in positions of ultimate power today re-running a similar playbook yet again for wall street and large public companies via lobbyists and political/regulatory capture.

No wonder, the average American has no confidence. The layoffs continue ... just heard that an old friend was just permanently laid off from a 25+ year postion at a large financial company along with with his entire department. Company is offshoring the jobs to save money. Fortunately his wife is a nurse, so they won't starve to death, but they have 3 kids in college so the financial repercussions will be significant as they have been for many millions of Americans.

Bernake and Geitner - stunningly bad. Larry Summers may well be even worse. Not to mention the revolving door of wall street to government rentals over the years such as Paulson, Rubin, Snow, and too many to count Goldmanites.


On Nov 14 08:12 AM wildebeast wrote:

Restoring confidence is probably one of the things these idiots thought would occur if they reinflated equities (success) and housing (failure). Joe Sixpack has seen through this fraud because the stimulus has been used to finance speculation rather than finance getting main street on its feet. Why Bernanke and Geitner still have jobs is one of lifes puzzles.

Nov 15 02:11 PM