A debt-ceiling dilemma, regional-banking woes and the market’s apparent predilection for ultralow interest rates have one common factor, according to Jim Grant, prominent author of Grant’s Interest Rate Observer: The Federal Reserve.
Grant has been a particularly tough critic of the central bank, which he says has caused a lot of damage to the economy and markets over the years, most of which he says was “unintended but not entirely unforeseeable.”
The respected author and market pundit says a period of artificially low interest rates that hovered at or near 0% gave root to the challenging environment that many investors are wrestling with now.
“The past 10 or 12 years in respect to Fed policy and the general suppression of the rate of interest” has sowed the seeds for the “regional-banking problems
the debt drama, the debt ceiling,” Grant said.
But, perhaps, his harshest criticism is this notion: “The Fed is problem No. 1 in American finance.”
“I think generally that the suppression of rates introduces all manner of distortions in the economy,” Grant told MarketWatch during a Thursday interview.
“It distorts savings. It causes people to go and reach for growth, for yields as if they were on their hands and knees with a flashlight looking under their furniture for some return on their savings,” he said.
That hunt for richer returns has caught many average investors offside in recent years but it has also left many financial institutions wrong-footed, including banks such as First Republic, which maintained a large portfolio of jumbo mortgages to wealthy clients on its balance sheet before most of the bank was bought by JPMorgan Chase & Co
JPM,
Such assets, across many banks, have lost value amid an aggressive succession of interest-rate increases by the Fed to quell high inflation.
Although down from a recent peak of 9.1% in June 2022, U.S. inflation remains historically and stubbornly high at 4.9% in April from a 5% reading in March on a year-on-year basis.
In the face such brisk inflation, the Fed has raised its benchmark interest rate dramatically, lifting it to a range of 5%-5.25% over the past 14 months, putting rates at the loftiest levels in about 16 years. The federal funds target rate, the benchmark that helps inform everything from mortgages to car loans, was between 0% and 0.25%, as recently as the first quarter of 2022.
Much of the market is anticipating that the Fed will pause its rate increases in mid June.
But signs of market strains from the recent moves in rates and still-elevated inflation will complicate matters for the Fed. The series of failures of institutions such as Silicon Valley Bank in mid-March, and the collapse of Signature Bank and First Republic highlight the pressures banks are contending with.
Stresses in the banking system are some of the unintended consequences to which Grant is referring. Worries within the banking system can cause financial institutions to be reluctant to lend and that dynamic can deliver additional downward pressure on economic growth.
Concerns about the U.S. government’s ability to pay its bills, with the U.S. bumping up against a $31.4 trillion borrowing limit amid a divided Congress, also fuels uncertainty.
And bets are growing that the U.S. will eventually fall into recession. One New York Federal Reserve Bank indicator points to a 68% chance of a recession within the next 12 months.
And if the rate-hike campaign pauses in June, it isn’t clear for how long because the work to tame inflation appears unfinished by some measures.
Core inflation, which excludes volatile food and energy items, rose 5.5% from a year earlier in April, a slightly slower increase than in March but still elevated. Core prices are seen by some as a better predictor of future inflation.
Fed Gov. Michelle Bowman signaled early Friday that she wasn’t on-board with the idea that interest rates could be held steady for the remainder of the year.
“In my view, the most recent CPI and employment reports have not provided consistent evidence that inflation is on a downward path, and I will continue to closely monitor the incoming data as I consider the appropriate stance of monetary policy going into our June meeting,” Bowman said, in speech at a European Central Bank conference in Frankfurt.
So is the Fed to blame for the current state of affairs? Hasn’t it done its part to alleviate pricing pressures that were partly sparked by a once-in-a-generation pandemic?
Grant believes that the market has grown accustomed to rates being so low for so long.
“The Fed has made a long series of errors,” he said.
Grant makes the argument that the Fed’s balance sheet resembles that of banks like First Republic.
“So the Fed, of course, isn’t the First Republic Bank but its balance sheet resembles that of First Republic and Silicon Valley Bank, in that it is earning 2% on its assets and paying 4-5% on its liabilities,” he said.
“It is itself a visible symbol of the problems and distortions brought about by this long, long period of artificially low rates,” he said.
Grant also questions the efficacy of the central bank’s policy interventions.
“I think that the basic idea of buying up bonds and thereby suppressing longer-dated interest rates, in the hopes of generating rising asset prices and thereby stimulating the economy by dint of people spending the proceeds of their capital gains, this idea that the Bernanke Fed surfaced in 2010-11 I think it is a very, very dicey proposition longer term. I don’t think it works,” he said referring to former Fed Chairman Ben Bernanke.
He said that the Fed continues to be the “handiest” its been on rate policy.
The Fed “can’t keep its paws off interest rates.”
The belief that the Fed will come to the rescue may account for the relatively healthy performance of stock-market indexes facing the threat of recession. The Dow Jones Industrial Average
DJIA,
is up 0.5% so far this year, the S&P 500
SPX,
is up 7.4% and the technology-heavy Nasdaq Composite Index
COMP,
is up over 17%.
What should an investor be buying in this environment? Grant says he has been identifying more things to sell than to own but remains bullish on gold. Gold futures
GC00,
are up over 10% in the year to date and an exchange-traded fund of miners, the VanEck Gold Miners ETF
GDX,
is on par with the performance of the Nasdaq Composite.
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