How high does the Fed go?

[BonVivant]

On interest rates, what I’m wondering is given how much US National debt there is (compared to the 1970s-1980s) is there a max cap beyond which the Fed can’t practically go (theoretically no cap, but…) in raising? And at that point, if there is still inflation, then you live with it. Inflate it away.  What do you all think?

[Luv2play]

I've been thinking about this too in Canada's case, which is similar to the US. Of course the two countries have to pay interest on their national debt and debt levels are very much higher than they were back when inflation was a problem like now. 

Of course the debt is staggered and a lot of the recent debt was incurred at very low, indeed historically low, rates. But older debt is coming due and will be rolled over at higher rates than what were available even 6 months ago.

So where is the limit where governments cannot sustain radically higher rates in servicing their own debt. 

[Guest]

It’s a provocative question.  I’m not sure we know the answer.  But, I surmise that given that governments pay interest with “printed money,” I doubt that the question even applies in the deliberation.  The act of paying interest with created money is, in itself, inflationary.  The harsh reality is that inflation makes paying back debt easier for the US when we pay back a $ borrowed last year with a $ only worth only  92¢ today and so on.

It may be a different path to the same question, but I think the more relative concern is Debt/GDP.   Why? Well, the federal budget only represents a subset of the economy -  that is, the transfer of resources in the economy through taxation.  aggregate economic output is much bigger.

Edited to add - I’ve not done the math on this (yet), but remember that one form of stimulus, the QE’s, involved buying debt securities in the open market to inject liquidity into the economy…thus, the government is both borrower and lender becoming a recipient of its own interest payments.  (Sidenote - When we put it in these terms, the circuitous nature starts to seem silly, right?)

Edited July 12, 2022 by BnaC

[+ augustus]

On 7/12/2022 at 4:00 AM, BnaC said:

The harsh reality is that inflation makes paying back debt easier for the US when we pay back a $ borrowed last year with a $ only worth only  92¢ today and so on.

Exactly correct!  

[EZEtoGRU]

Personally, I feel the Fed has mismanaged interest rates for the last 10 years or so...until the recent increases.  The Fed rate was kept far too low for far too long...but that's a discussion for a different thread.

We survived inflation in the 70's/80's and we will survive it now.  Retirees used to live off of the interest earned on their CD deposits in the 70's/80's.  They were pissed when that ended as interest rates fell!   I did substantial travel to Brazil/Argentina in the 80's/90's when both countries experienced hyperinflation.  You learn to live with it.  BTW, the US is no-where near a hyperinflationary situation.   

All things staying equal, I suspect the high inflation rate just reported for June will be relatively short-lived.  Energy prices are dropping.  If that continues, other prices will go down to a degree.  The US economy remains strong.  Unemployment is low.  Indeed we need more workers.  Obviously, global factors out of our control can have an impact on inflation.  

I am not too worried about it but I maintain a watchful eye.

 

[Luv2play]

If interest rates are pushed too high by the Fed and the Bank of Canada, it will provoke a recession. At that point the GDP starts to shrink and the debt to GDP ratio skyrockets. That's when the burden of government debt starts to weigh on the federal governments.

Debt payments then start to crowd out other program spending like Social Security or Old Age payments in Canada, defense, education, health care etc. If governments aren't careful, as debt servicing charges increase as a proportion of overall government spending, the credit agencies start to lower their ratings on all existing debt. 

Then watch out. Printing more money will only lead to more credit downgrades and it becomes a vicious spiral. Governments then need to make painful spending cuts. It's happened before. In Canada's case in 1994. I was around to witness that personally. 

[+ augustus]

3 hours ago, Luv2play said:

In Canada's case in 1994. I was around to witness that personally. 

Yes, Canada had a failed auction when no one would buy the government's debt.  Drastic action had to be taken.  The situation is even worse today.

[BSR]

3 hours ago, EZEtoGRU said:

Personally, I feel the Fed has mismanaged interest rates for the last 10 years or so...until the recent increases.  The Fed rate was kept far too low for far too long...but that's a discussion for a different thread.

We survived inflation in the 70's/80's and we will survive it now.  Retirees used to live off of the interest earned on their CD deposits in the 70's/80's.  They were pissed when that ended as interest rates fell!   I did substantial travel to Brazil/Argentina in the 80's/90's when both countries experienced hyperinflation.  You learn to live with it.  BTW, the US is no-where near a hyperinflationary situation.   

All things staying equal, I suspect the high inflation rate just reported for June will be relatively short-lived.  Energy prices are dropping.  If that continues, other prices will go down to a degree.  The US economy remains strong.  Unemployment is low.  Indeed we need more workers.  Obviously, global factors out of our control can have an impact on inflation.  

I am not too worried about it but I maintain a watchful eye.

 

My aunt recalls how giddy she was when her CDs in the 70s/80s hit a 14% interest rate.  She and my uncle were exceptional savers and kept all their money in CDs because of my uncle's mistrust of the stock market.  But high interest rates rob Peter to pay Paul.  Sure, she was getting 14% interest, which she could see in her bank statements.  But the bank statements did not show that the principal was being eaten up by inflation.  As awesome as it was to get $140K in interest, my aunt ignored the eensy weensy detail that the $1 million principal had shrunk in value to just $830K.  Plus you're paying taxes on that $140K.  Seniors might have felt like they were making money, but they weren't. 

As for your prediction that inflation will ease soon, we can only hope.  We heard the same thing back in January ("relax, it's only temporary"), yet here we are 6 months later with the highest inflation rate in 40 years.

Correct, the US is nowhere near hyperinflation, but I question your argument that people just learn to live with it.  Hyperinflation can cause a person's life savings to diminish to almost nothing.  Most people figure out how to forge on, but recovering from such devastation requires a helluva lot more than just learning to live with it.

Edited July 14, 2022 by BSR
Wording

[+ augustus]

2 hours ago, BSR said:

Correct, the US is nowhere near hyperinflation, but I question your argument that people just learn to live with it.  Hyperinflation can cause a person's life savings to diminish to almost nothing.  Most people figure out how to forge on, but recovering from such devastation requires a helluva lot more than just learning to live with it.

Inflation is insidious.  It's a transfer of wealth from savers to debtors.  

[BonVivant]

3.5% maximum is one recommendation. See: 
https://www.thestreet.com/investing/legendary-financier-bill-gross-blames-these-two-factors-for-inflation?puc=yahoo&cm_ven=YAHOO&yptr=yahoo

There is definitely a maximum rate because the global economy can’t take anything too much higher than that. Essentially the only option for the USA and other developed economies is further debasement of the currency. Some developing ones may have no choice but to default - see Sri Lanka. 

I also think there will be a wave of individual bankruptcies at the personal and business level. Debts levels are too high. 

[Guest]

I don’t know what the max “trigger” is, but I suspect we will have Fed Funds at 4.125+/- at the peak of this cycle 

[BonVivant]

Even if the Fed goes to +\- 4% I think we’ll be in negative real rates for a while….. 

[+ augustus]

17 hours ago, BnaC said:

I don’t know what the max “trigger” is, but I suspect we will have Fed Funds at 4.125+/- at the peak of this cycle 

Could be greater than that.  All depends on how soon or if inflation moderates.  Stagflation is a very difficult situation.  Even if GDP declines you can still have accelerating inflation.

[BonVivant]

How high will they go now? I think the Fed stands pat now. Inflation is falling. Thoughts?

Edited October 8, 2023 by BonVivant

[+ FrankR]

38 minutes ago, BonVivant said:

How high will they go now? I think the Fed stands par now. Inflation is falling. Thoughts?

JPMorgan’s Jamie Dimon made some comments last week which leads one to believe that there are more hikes coming and rates will stay higher for longer than most expect. It would be wise to prepare for that scenario. 

Edited October 8, 2023 by FrankR

[EZEtoGRU]

3 hours ago, FrankR said:

JPMorgan’s Jamie Dimon made some comments last week which leads one to believe that there are more hikes coming and rates will stay higher for longer than most expect. It would be wise to prepare for that scenario. 

I mostly take Jamie Dimon's comments with a grain of salt.  He has been preaching an upcoming recession for three years now...and it still hasn't happened.  Having said that, I do expect one more quarter point rate increase before the end of the year.  That may be the end of the increases if inflation continues falling.  Recent economic reports continue to be good.  Last week's jobs report totally busted through expectations.

[+ The Big Guy]

I think we might see a pause over the next year since we are headed into an election year.   No one wants to believe the Fed is political but I think they will try to stay out of the way unless things get worse.  

[+ tassojunior]

It seems Modern Monetary Theory is being accepted by the US but we don't really know the details yet. Brave new economic world.  

[pubic_assistance]

35 minutes ago, tassojunior said:

It seems Modern Monetary Theory is being accepted by the US but we don't really know the details yet. Brave new economic world.  

Raising interest rates just as the economy is trying to recover from the extended Covid restrictions is not Modern Monetary Theory. It's another obvious attempt at crushing the little guy so Mega-Corporations can gobble up yet another percentage point or two of the market.

Banks, Credit Card companies, Mega-Retailers and and Real Estate companies in the US made huge profits off the misery of people who's life savings collapsed during the Covid Panic.

[BonVivant]

MMT is a fiasco wrapped up in a fad. Has never worked since the beginning of recordkeeping and history. 

[ICTJOCK]

I've been concerned that the Fed continues to pose a "hawkish"  stance at this moment based on the behavior of job creation and several other points.

We'll see if they raise interest rates another 25 basis points or leave it alone.  I think holding off has been a good thing to properly evaluate.