The Fed will be forced at some point to raise interest rates. When the central bank does, it could become a crisis of mega proportions as the amount of money required to service the nation’s massive debt equals nearly one third of the country’s annual budget.
Markets are awaiting the Fed meeting this week and looking forward to hearing commentary from Chairman Jerome Powell following the decision on Wednesday. Rising inflation worries, a potential economic slowdown and the resurgence of the viral pandemic are just a few of the issues at hand the Fed must contend with. The central bank may now find itself in an impossible situation, however, and markets may scream bloody murder when the Fed finally decides to take its foot off the gas pedal.
The primary risk of the Fed electing to hike interest rates is that the changes will be made on the short end of the curve, but will also affect costs which will become unaffordable. The argument could be made for the U.S. issuing longer-term bonds, possibly 100 or even 500 year bonds, but
it is not. The focus on refinancing on the short end of the curve will eventually lead to a crisis as interest costs rise and become unsustainable.
Rather than suddenly deciding to begin hiking interest rates, however, the Fed may be more likely to announce a tapering of its monthly security purchases, or QE. The Fed is still buying mortgage-backed securities, and that is an asset class that could be the first to be cut. The housing market is on fire right now, so one has to ask the question of why the Fed feels the need to juice that market.
Whichever way the Fed decides to go, it will likely not be pretty. The stock market has been making fresh all-time highs for some time now, arguably on the back of artificially low interest rates and QE. Once the central bank removes the punchbowl, it is difficult to say how markets may react but the possibility of a large meltdown exists. Given the run up in equity markets over the last several years, the decline in stocks could be swift and severe, possibly even nastier than the drop seen in 2008-2009.
A sharp decline in equity markets could set the stage for sharply higher gold as investors seek out alternatives. Against the current backdrop of economic and geopolitical challenges, a weaker dollar and the viral pandemic, investors may become increasingly interested in asset classes with a reputation of reliability. With its long history as a reliable store of wealth and protector of value, investors may find no better alternative to turn to than gold.
The countdown to action by the Fed has already begun. Some Fed members have already suggested the central bank begin tapering its asset purchases sooner rather than later, and calls for the Fed to begin hiking rates may increase as inflationary pressures mount further. The next several months could see increasing market volatility as investors attempt to figure out the Fed’s plans, and that volatility could lead many market participants into the gold market.
The Fed’s actions may not only affect stocks and other markets, but may also put pressure on the dollar as well. Dollar weakness is a major factor for the gold market, and any further downside in the greenback could keep buying interest in gold elevated.