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Inflationary Bust Or Deflationary Bust? What Will The Fed Choose?


  • Decision time.
  • A path, and precedent, have been set.
  • How long will this path continue?


For better or worse, it appears that the Federal Reserve is set on a path where they raise interest rates only at meetings that are followed by formal press conferences. This is the precedent set by the Janet Yellen Federal Reserve, and it looks like Chairman Powell will follow suit. Effectively, this locks the Federal Reserve into four interest rate increases, at most, during a calendar year.

With an interest rate increase predicted for the June meeting, what is the path for the rest of the year?

Will the Federal Reserve get behind the curve, providing a spark for inflation, or will they engineer a deflationary bust?

Robert P. Balan posed this question in a recent SA article, and I think it is one that all market participants should attempt to answer.

The following is my take.


The Federal Reserve has slow played interest rate increases thus far, engineering the slowest tightening cycle in modern market history, and thus, the Fed, is likely to stay behind the curve.

An Epic Bull Market Without A Speed Limit

Nine years into one of the longest equity bull markets in modern market history, the Federal Funds rate, today, is still below 2%, sitting currently at a target range of 1.50%-1.75%.

For perspective, this is lower than the Fed Funds rate following the bankruptcy of Lehman Brothers, in the midst of the 2007-2009 financial crisis. Thus, it is an understatement to say that short-term interest rates have been accommodative.

(Source: St. Louis Fed)

Looking at the chart above, there has never been a previous tightening cycle that is remotely close to the current one. Think about that for a minute.

Have low interest rates artificially inflated the U.S. stock market?

With the premise that a picture says a thousand words, I will provide

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This article was written by

KCI Research Ltd. profile picture

KCI Research, aka Travis, has been a financial professional for over 20 years. Formerly a director of research at a mid-sized RIA, and one of four strategic investment decision makers at one of the largest RIA's in the United States, Travis founded his own boutique investment firm in February of 2009. He specializes in against grain investing backed by real-world wisdom and experience by targeting out-of-favor, contrarian investment opportunities.

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Analyst’s Disclosure: I am/we are short SPY AS A MARKET HEDGE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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Comments (26)


As the US faces global competition from China, Pacific Asia, Brazil, India -- do you really think the U.S. can ever pay back (or even stabilize) $20 plus trillion national debt, cover the pension debts, and the medical costs of its aging and obese-ing population?

Yes, you can try to inflate your way out of it, but if the world decides the dollar is no longer worth it as a reserve currency, where will U.S. end up?
Inflation is our only chance to help fix our debt. If it doesn't work it's gonna be bad. Real Bad.
I believe Trump will pressure Powell and the FED to facilitate inflation. If we go into a prolonged period of deflation, Trump reelection prospects will be toast.
Remember, Trump is a bankruptcy specialist.
DWD Investing profile picture

As far as rate increases and your general thesis, I have no questions. However, I keep seeing this "9 year bull market longest in history" idea popping up as a concrete concept to analysis. I think it's right technically, but I have an unorthodox idea about how it doesn't quite work like that.

Using your SPY 1999-2018 Chart above:
Between 1999-2012 you made efectively zero on the stock market. The stock market had a lot of ground to make up after 2012, or it wouldn't even be worth investing. After all, that's 10-12 years of your investment life lost.

In affect, if you got in to the market in 1999-2000, the bullmarket only started in 2013, at which time around 2013, you got even again. In fact, again using the same chart, reversion to the mean incline would make it around 235. It's 260 now, so it's right in the ball park. Going back further to draw a lower revision line doesn't work because the previous market doesn't take into considertion the growth of the tech industry.

This is probably really wrong on my part, but as a simple investor, losing 10 years of your investing time between 1999-2012 really doesn't mean along bull market is unsustainable (or that is sustainable). Moreover, if the "bull" market really started in 2013, like I suggest above, and as such, it's 5 years old, not 9 years old.
turb0kat profile picture
Maybe the 2000 peak was 20 years ahead and not just 10? In Japan the market got 30 years ahead of its valuation...
Smart money got in 2009 with bailouts & QE & rock bottom interest rates.

2009 - 2018 = 9 years

At 9 years and lengthening, can't help but wonder if smart money is pondering when to exit, as the interest rate dilemma questions heat up.
Jack Reacher,
if nothing else, you "shoot well" and your character is very entertaining.
Read the books by Lee Child.
Well--the charts and premise are tilted --we already had a 12-14 year sideways market.

And I vote for deflation.
"Some say the world will end in fire, Some say in ice. From what I've tasted of desire I hold with those who favor fire. But if it had to perish twice, I think I know enough of hate To know that for destruction ice Is also great And would suffice." - Robert Frost
too much stuff chasing too few $$'s
too many people over extended regarding credit so
FEWER purchasing $$'s going forward as credit tightens.
money in the hands of the rich is NOT SPENT!!!
it is simply a means to making more money via the stock market.
MAIN STREET suffers but things will get CHEAPER!!! as margin compression
overtakes all product and service arena.
DEFLATION will be followed by some form of hyper inflation as the fed
over reacts. ultimate outome? either a severe move toward socialism(freebies)
or civil unrest.
Socialism— the Millennials have gotten a rotten deal with massive student loans, low salaries, expensive unaffordable homes, etc.
They will vote for higher taxes to pay for National Health Insurance/socialized Medicine and subsidized College tuition. And also gun control.
firstinsnow profile picture
Rising interest rates really hurt the struggling middle class,
when they are enacted in a hurried manner.
Just look at your credit card interest rates, as they have
been trending upward at an alarming pace.
There is no reason for this rush to increase the Federal
Reserve interest rates, except to pump up the already more
than solvent large banks.
Less is more for all.
"Rising interest rates really hurt the struggling middle class"

Yes, I agree that the interest rates for well-qualified middle-income home buyers should be less than interest rates for corporations borrowing to buy back stock, or for very large buyers of stocks who buy on margin.

Any ideas on how to implement that, when the corporations, big banks, CEOs, managers, make hefty campaign donations that help elect presidents and congress-persons?
Although the author doesn’t actually say it, I think he’s predicting inflation. Correct?
He says it, but puts the words in two different places.

To clarify, put the punchline first:

"As volatility in the financial markets increases, it is my prediction that...


...consistent with their policy course over the current bull market."

And put the earlier question second:

"Will the Federal Reserve...

...get behind the curve [= "undershoot their projected tightening schedule"], PROVIDING A SPARK FOR INFLATION,

...or will they engineer a deflationary bust?"

If their is Fuel & Oxygen around [demand for goods & services with access to credit], then the Spark [continued relatively-easy credit] will ignite the Inflation Furnace.
"I think he’s predicting inflation"

My perspective is that we have actually had considerable "inflation", just not in the form the Fed has been looking for.

Instead of the easy credit inflating the general economy, it has inflated the stock market (partly via buybacks) to very high valuations and high PE's (relative to the GDP & general economy & overall wages).

[NOTE: In this context, the GDP DOES need to be adjusted for balance between U.S. and global contributions to profits of U.S. listed companies.]

Not much inflation into the general economy up to now, because foreign labor has remained cheap (keeps prices down), automation & productivity have advanced (keeps prices down), and unions are too weak (compared to the old days) to get wage hikes commensurate with corporate profit gains.

[Also, here's much overlooked change since 60's & 70s:

Two incomes per household is much more common now, which helps conceal/offset lack of commensurate wage gains for MC wage earners.

A head of household in the 60s/70s was commonly the sole wage earner and made enough working at a quality-job/unionized factory to support the whole family.]

If everybody owned stocks (as a significant portion of their net worth and income), and the inflation index factored in exceptional rises in the stock valuation [when stocks as a whole rose far above a GDP-based "reasonable valuation"] -- the inflation goals of the Fed might have been exceeded some time ago.
10Y rates will peak at around 3.25%.
From there rates will be pulled down by gravity to Germany & Japan and the declining
Dividends seekers will rock & roll.
You cannot make money on an old 78 record, or dividends from radio stations.
You have to be on the road.
You have to perform in your own show.
Inflation as a usual
In europe, people have a lot of money, so deflationary collapse is out of the question in my mind. Inflation all the way.
Which sin is worse? A slow rise seems a better sin than fast.
In my opinion, the Fed will never willingly accept deflation because asset price devaluation would result in banking system insolvency. Even the Fed isn't big enough to counteract that once banks begin to fail and confidence is shattered. Deflation was essentially abolished by the Fed in the 70s after decades of cyclical inflation and deflation. The result is massive structural imbalances that would tip the world into an unimaginable crisis if deflation were ever allowed to occur. This is why the new definition of price stability is 2% inflation, a notion that could never stand against the simplest test of logic. A dust up is coming...the big question is whether or not the Fed and its inflation loving savants can pull another inflationary rabbit out of their Bullwinkle magic hat.
The sin was enabling credit expansion so far beyond what the economy can service. The hard choices that could/should have been made long ago are no longer viable solutions. Now we live in a permanent state of monetary experimentation from which no path of escape exists. This is my opinion but there are dozens of people with better educations and more experience than myself who share it. I like Powell and think he's the best Fed chair we've seen since Volcker...problem is he arrived 20 years too late.
Gosh, Oh My! profile picture
Once CD Rates for one year are 3℅ the stock markets will go south hard!
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