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What if the Fed Lowers Instead of Hiking Interest Rates!

The Fed will have to admit defeat

If is not in May it will very likely be in June. When the Fed will finally be forced to be honest and admit that it is wrong on the economy and therefore will have to drop its tighter monetary policy with as consequence that precious metals assets will skyrocket. A U-Turn by the Fed changing their policy direction from tightening to easing will create a massive market shock. That day is rapidly approaching.

As Michael Belkin says "financial markets are a case of the blind leading the blind. The Fed keeps talking economic strength and has broadcast a series of interest rate hikes and even balance sheet reductions, those consensus trades have virtually all market participants incorrectly positioned." This is in my point of view because almost everybody got drugged for the last 8 years and thus lost perspective of what is real and what isn't.

That the Fed will have to ease instead of tighten is something I and with me several more people have been arguing the last couple of years. As they say when you are too far ahead of foreseeing what will happen you are regarded as a knucklehead whilst if you predict the situation a few weeks before it happens you are viewed as a genius. The reason for a U-Turn is that according to my and other people's perception the economy was and is very weak whilst the Fed is trying to portray, using manipulated economic figures, a strong economy to try and boost consumer confidence hoping the economy will find traction. Though this hope has been in vain and hence the Fed has become a prisoner of its own falsifications and realistically can't increase interest rates and most likely will have to cut interest rates again rocking the investors' community. In my point of view the only Fed statistics that come close to what the real situation on Main Street is are those of the Atlanta Fed.

The Atlanta Fed is now forecasting GDP growth of 0.5% for 1Q17

On April 17 the Atlanta and New York Reserve Banks downgraded their outlook for U.S. economic growth for the first quarter after disappointing data on retail sales. The U.S. Commerce Department reported retail sales falling 0.2% in March following a 0.3% decrease in February, which was the first and biggest decline in nearly a year. As a result the Atlanta Fed reduced first-quarter gross domestic product, GDPNow, to 0.5% down from the 0.6% growth rate calculated on April 7. On April 17 the New York Fed also downgraded first-quarter GDP at 2.09% from 2.56% a week earlier (quite a reduction!).

The next GDPNow update is Thursday, April 27.

GDPNow Forecast

Anyway just see on the chart here above how out of whack the forecast of the industry analysts are with GDP forecast for the first quarter of between 1%-2% or between 2x-4x more than the Atlanta Fed is forecasting. Wall Street is always too late in their downgrades because of their positive bias, followed for obvious reasons, Wall Street makes more money with a positive than a negative stance.

In my point of view it all is pretty simple. People just simply don't want to further increase their debts in order to buy goods they already have. The numerous vacant stores in New York, even not seen in the 2008/2009 period, are a clear testimony to that. I believe the fact that Ralph Lauren, a popular brand amongst Americans and foreigners, is closing its flagship store on Fifth Avenue is a clear sign of this trend. People are just fully saturated with debt and consumer goods, people are maxed out. No room left! And just recently the BofA in its almighty wisdom "concluded" that surging consumer confidence does not result in higher spending hence why the retail sector is doing so badly. And as we all know consumer-spending accounts for 70% of GDP in the US. Just draw your own conclusion. You can bring a horse to the water but you can't make it drink and especially not when it doesn't trust the water!

Dallas Fed president still talking about 3 hikes being a good baseline!

And despite this all the Dallas Federal Reserve President Robert Kaplan said on Thursday April 20 that two more interest rate hikes this year remains possible but that the U.S. central bank has the flexibility to wait and see how the economy unfolds. "Three rate increases this year...is still a good baseline. If the economy develops a little more slowly, then we can do less than that and if the economy is a little stronger, we can do more than that," Kaplan said in an interview with Bloomberg TV. This guy is living in La La Land. Following the abovementioned GDP figures 2 or 3 further interest rate hikes indicated by the Fed are out of the question in my point of view! The economy just can't take it. And now Goldman Sachs is suddenly starting to get cold feet and in a note released overnight, the firm's chief economist Jan Hatzius says that "we have become a bit less confident about near-term hikes." Is this what they call "hedging" (I am facetious of course)? Anyway we will soon witness what the outcome will be. The next meeting will be May 2-3 followed by a meeting on June 13-14 see dates below.

FOMC Meeting Dates For 2017

Month Date
January/February 31-1
March 14-15*
May 2-3
June 13-14*
July 25-26
September 19-20*
October/November 31-1
December 12-13*

*Meeting associated with a Summary of Economic Projections and a press conference by the Chair.

Fundamentals and market valuations are worrisome

With the diminishing returns from the QEs and ultra low interest rates, an U6 unemployment figure of 22.5% (ShadowStats), a record 95m Americans not in labor force (the number grew 18% since 2009) and according to a recent Bankrate survey of 1,000 adults, 57% of Americans that don't have enough cash to cover a mere $500 unexpected expense, the outlook for the economy is not good to say it at the least.

The last time continuing jobless claims, just published, was this low, or 1.979 million, the Nasdaq peaked at the end of the dotcom boom and collapsed over 80% in the next 2 years. One has to wonder that despite a slump in industrial production we had the 'best' continuing jobless claims print since April 2000 tumbling to 1.979 million. You know why in my opinion? Because people are so disillusioned that they have given up looking for jobs, hence why the labor participation rate is at historic lows. Unemployment rate 4.5%! don't make me laugh it is a concoction of that liar in chief Obama. According to a new study from the Census Bureau, roughly one-third of all millennials live at home with their parents and one-fourth of them can't be bothered with enrolling in school or finding a job.

Continuing Jobless Claims

Labor Force Participation Rate
Foto: Business Insider/Andy Kiersz, data from Bureau of Labor Statistics

Next to the weak fundamentals the markets are very overvalued. The Q or Buffett ratio, standing for the stock market valuation ($22.6trn) divided by the total size of the economy ($18.8trn) puts the Buffett valuation at around 1.2x, meaning the stock market is about 20% pricier than the entire US economy. According to Yale finance professor Robert Shiller the S&P 500 SPX is now trading on a cyclically adjusted price-to-earnings (cape) ratio of 30x, compared to a historic fair value for this measure of about 16x. In other words prices are very lofty and thus very vulnerable to shocks.

Dollar at crucial levels and so are gold and silver

When the Fed will finally admit to the weakening of the economy thereby frustrating further rate hikes and possibly triggering a rate cut the financial markets and US dollar could end up falling significantly. Though most likely in anticipation the markets will front run the Fed and weaken the US dollar in advance of any announcements by the Fed. Another important factor that could contribute to a much weaker dollar in this respect is the fact that on April 9 net Treasury futures shorts were back to their lowest levels since early December 2016 whilst traders continued to pile into the massively short-end betting on further rate hikes as Eurodollar shorts push on beyond $3 trillion. This is often a contra indicator of how the currency will react when too many positions are taken in one direction. The vulnerability of those trades often rises significantly when positions reach extreme proportions and often result in the opposite outcome because of the need of immediate covering before others do when high expectations are not met in order to limit losses.

So instead of being regarded a beacon of strength the US dollar is most likely to lose its luster. I think people start to lose their trust in the financial system and are looking for an asset class which attractiveness stands on its own and is not determined by fake statistics. Although we all know that the Fed, the BIS and the bullion banks have been defending the US dollar by discouraging investors to invest in gold and silver the fundamentals for gold and silver are now catching up (just look at the tug of war in the futures market) and there is no place to hide anymore for the scam artists.

And because the central banks will lose their status of lender of last resort because they have undermined the economies and currencies investors will resort to the ultimate lender of last resort: physical gold and silver. The upcoming weakness in the US dollar, which is inversely correlated to gold, will force deliveries of physical gold on the Comex instead of the usual nominal settlements in US dollars which in turn will force the price of gold and silver to multiples of their present value.

And the outlook for the US dollar is I believe supported by the charts that are kind of indicating the weakness in the US dollar and the strength of gold and silver. As we can see on the US dollar chart below the 99 level being the 200-day moving average is quite crucial for the direction of the US dollar. And the authorities will do everything to defend that level.

US Dollar Index Daily Chart

Though when the US dollar index convincingly breaches the 99 level, with potentially geopolitical triggers, we most likely will see 92-94 before falling to 70 if and when "justified" by fundamentals and sentiment. When we break crucial levels things will start feeding on themselves.

US Dollar Index Point and Figure Chart

The inverse correlation a result of the gold and silver price being expressed in US dollar is showing a very near break-out (see below). And as charts show the further in time we get the more certain the break-out will be. It is just a matter of time. AISC or All In Sustaining Cash costs for gold are between $1,100 and $1,300. In other words the downside is very limited because below these levels there are not many gold producers that will be profitable.

Weekly Gold Chart

A war the Fed, BIS and bullion banks are finally losing

As mentioned here above there is clearly a tug of war going on in the futures market. There are record short positions in the gold and silver markets and especially in silver with the longs not getting flushed out. The number of strong hands, investors that believe in the long-term prospects for gold and silver and are holding on to their positions, are clearly increasing. The Fed and the bullion banks dumped 22,000 futures contracts on Tuesday April 18 just before the London fix, which resulted in a $8, fall of the gold price in order to rise subsequently $15!!! In my point of view this is a clear sign of the increasing demand for gold from investors to hedge themselves against the geopolitical risks, peak markets and an imminent weakening of the US dollar whilst the Fed and bullion banks seemingly are losing their control in depressing the gold and silver prices. This dumping was respectively repeated on April 19 when 20,000 futures contracts were sold. Both dumps had a notional value of between $2.5-$3bn (20,000 x 100 x 1290= $2.58trn).

Conclusion: gold and silver are the lenders of last resort

Next to the geopolitical tense situation in North Korea and Syria we have French elections on April 23. On April 25 the anniversary of the Korean People's Army is celebrated with possibly new provocations whilst on April 28 we have the deadline for the US government to pass a new funding bill. Congress is on holiday till April 25 and it's unlikely they will do anything other than pass an "extraordinary funding measures" bill to allow the debt ceiling can to (yet again) be kicked down the road. Anyway a lot of events that could possibly lead to spikes in the equity and bond markets and the US dollar and gold and silver. And then last but not least of course the Fed meeting on May 2-3 which I will follow with great interest.

As described in my last article http://www.safehaven.com/article/44172/the-next-crisis-is-the-mother-of-all-counter-party-risks-part-2 the mother of all counter-party risks in the end is the devaluation of your currency, the purchasing power or the real goods you can buy with your nominal money. And the CBs have issued so much money without the expected productivity gain that now the law of dimishing return is having the opposite affect and is undermining the value of the reserve currency. You just have to look at what happened in Japan since 1989. And as we know in 2008 the banks created the crisis now the central banks are creating the crisis by undermining the currencies .

Central banks (ECB & BoJ) have bought $1 trillion of financial assets just in the first four months of 2017, which amounts to $3.6 trillion annualized, "the largest CB buying on record." As Hartnett of BoA notes, the "Liquidity Supernova is the best explanation why global stocks & bonds both annualizing double-digit gains YTD despite Trump, Le Pen, China, macro..."

Central Banks' Balance Sheet

Liquidity Supernova

Central Banks Balance Sheet by Country

Aggregate Balance Sheet of Large Central Banks

According to the chart here below any time the central bank punch bowl is taken away, an unpleasant "financial event" inevitably happens.

Fed Tightening since 1915

We are at the end of a long economic cycle. And the central banks haven't been able to "help us out" we are on our own and therefore preserve your capital by acquiring physical gold and silver, the ultimate lenders of last resort. You can't trust the Fed. The Fed will have to admit defeat and reverse policy and it won't miss its impact on the markets and more importantly the dollar and gold and silver.


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