Last week you saw the Federal Reserve officials publish their March meeting minutes. These revealed that nearly all of the members have become hawkish and determined to continue raising interest rates and reducing the size of the central bank balance sheet. The strength of the economy and increasing levels of inflation have persuaded them that additional interest rate increases are necessary.
The problem is that debt has massively increased since the end of the Global Financial Crisis a decade ago. The repercussions of raising rates back to levels long considered historically normal could set off a debt explosion. Gold offers insurance and protection during market turbulence. This is another good reason why you need a gold IRA to protect your retirement savings. It is not too soon to start considering what gold goes in an IRA today.
March Fed Minutes Show FOMC Remains Hawkish
For any Fed watchers who had doubts on how hawkish the FOMC has become, last Wednesday’s Federal Reserve minutes put those to rest. All participating members described an economy that is strongly growing and inflation that is picking up pace. This is enough to validate ongoing increases in the interest rates.
The March minutes revealed that the nation’s central bankers remain hopefully optimistic about where the economy is going. Only a few misgivings among several members remained. Such a near consensus will push the Fed to keep raising interest rates throughout 2018.
The vote for the one quarter point interest rate hike (to the 1.5 to 1.75 percent range target) emerged as unanimous. Several participating members thought it might be better to wait on additional evidence that inflation was truly picking up towards the stated Fed goal of two percent. The meeting summary notes were telling:
“Participants generally saw the news on spending and the labor market over the past few quarters as being consistent with continued above trend growth and a further strengthening in labor markets. With regard to the medium term outlook for monetary policy, all participants saw some further firming of the stance of the monetary policy as likely to be warranted. Almost all participants agreed that it remained appropriate to follow a gradual approach to raising the target range for the federal funds rate.”
In other words, more interest rates will be following in the near future.
FOMC and Other Central Banks Moving Away From Accommodative Policy Stance
This is the meeting where the FOMC members thought seriously about changing their language in upcoming statements. They are debating changing their official policy stance from “accommodative” begun a decade ago to “neutral or restraining.” It would mark a change from trying to increase growth to controlling it. This has been encouraged by their views on the recent $1.3 trillion spending bill and end of 2017 $1.5 trillion in tax cuts, as their minutes revealed:
“Tax changes enacted late last year and the recent federal budget agreement, taken together, were expected to provide a significant boost to output over the next few years.”
Relevant markets have already factored this and additional interest rate increases in to some extent. Fed funds futures data shows that markets anticipate the Federal Reserve will boost rates in June and probably in September as well. Any fourth hike for this year is given a roughly 25 percent chance. Yields on U.S. Treasury notes have jumped from 2.4 percent to 2.8 percent so far this year in response. The chart below shows the rising trend:
Analysts and economists believe the other major central banks will soon follow the Fed’s lead. Both the European Central Bank and the Bank of England have given indications of normalizing their interest rates before long. The ECB is moving towards reducing its program of bond purchasing as well.
Debt Levels Are Now Dangerously Higher Than Before the Crisis
The major problem with these policy moves is the impact that they will have on dramatically increased debt levels since the Global Financial Crisis occurred. The Institute of International Finance shows that worldwide debt attained an all time high of $237 trillion for last year. Debt amounts have grown by $68 trillion since year 2007 and the onset of the crisis. This increase is greater than 50 percent of the world’s entire GDP.
Developed markets have taken on the greatest amounts. Their debt to GDP ratio now stands at approximately 380 percent. Yet even the emerging markets now showcase over 200 percent ratios. Thanks to the last decade of historically low interest rates and a world awash in liquidity both governments and the private sector have amassed debts at these unheard of levels.
Exploding Debt Levels To Amplify Effects of Rate Increases
The real danger comes from the consequences of higher interest rates on so much runaway debt. Both debt ridden governments and companies will run the risk of crippling financial problems. The value of especially high yield and higher risk corporate bonds will be most significantly affected. Investors have flocked to these in an effort to attain higher yields. These losses will pass through to banks whose credit risks have been rising. Already in 2018 bank credit risk metric the LIBOR overnight index swap spread has jumped from .2 percent to .6 percent.
A second problem will be the substantially declining value on current holdings of debt. It only needs a one percent rise in interest rates of U.S. government bonds for the resulting losses to surpass $2 trillion around the globe. This does even include hits from corporate and other bonds that will only increase the bleeding red ink and pain. It will require many bond owners like banks to increase their capital or sell their bonds at losses. This creates a vicious cycle that only pressures rates further. Bank losses would impact their ability to issue loans and credit.
A third impact of rising interest rates will be to push investors out of riskier assets like stocks and into bonds. This will decrease stock values. It could impact the collateral that underlies debt financing. It would also spell an end to acquisitions and share repurchases that have been paid for with debt. This has underpinned stock prices for years.
Debt Service Will Become A Serious Problem with Higher Rates
The fourth effect of higher interest rates will be a diversion of investable cash to debt service. All time high levels of borrowing in a number of nations mean that individuals will have to reduce spending, companies cut back on investments, and governments slash services.
The last cataclysmic impact of rising rates will relate to governments and their ability to utilize effective fiscal stimulus. The United States is only two years away from ongoing trillion dollar yearly budget shortfalls beginning in year 2020. This will only add to the over $21 trillion national debt.
Rising interest rates and deficits will lead to a vastly greater amount of annual revenue going to service the government debt. The Congressional Budget Office has revealed that by 2028, the net interest payments will increase to 3.1 percent of annual GDP from the 2018 level of 1.6 percent. This will only worsen if the higher interest rates, geopolitical problems, and trade disputes slow growth down.
Gold Will Protect You from the Financial Instability
All of these projected negative consequences of the higher interest rates are a sobering reminder of why you should invest in gold. The yellow metal has protected investors from financial instability throughout most of human history. Now all you need to know is how to invest in gold.