As October unfolds, this month promises its share of surprises, and the recent events involving Hamas’s sudden attack on Israel, followed by Israel’s declaration of war, certainly fit that narrative. What else lies ahead?
The trajectory of the U.S. economy and financial markets in the coming months will largely hinge on consumer price inflation, interest rates, and the price of oil. A new conflict in the Middle East could significantly impact these core economic factors.
The extensive money printing spree that began in 2020 has not truly abated. Although the Federal Reserve has increased the federal funds rate by 5.25 percent and has slightly reduced its balance sheet—from $8.9 trillion to $7.9 trillion—the federal government continues its reckless borrowing spree. The fiscal deficit for the 2023 financial year reached a staggering $1.7 trillion, translating to more than $4.6 billion borrowed daily.
This relentless borrowing contributes to a national debt that has surpassed $33.5 trillion. When accounting for unfunded liabilities—such as social security, Medicare Parts A, B, and D, federal debt held by the public, and veteran benefits—this debt balloon to over $194.6 trillion.
Attempting to curb consumer price inflation amidst rampant deficit spending is almost impossible. Although inflation rates, gauged by the consumer price index (CPI) or the Fed’s favorite, the personal consumption expenditure (PCE) price index, may have slightly decreased since last year, a return to a low 2-percent inflation rate is unlikely without a significant recession.
Consequently, interest rates are expected to remain elevated compared to previous years. For instance, the current 10-Year Treasury rate of 4.98 percent, while not alarmingly high in a historical context, is considerably higher than the historic low of 0.62 percent recorded in July 2020.
Interest Rate Flux
The swift changes in interest rates create substantial challenges for both the economy and financial markets. The shift from the interest rates of just three years ago profoundly affects debt dynamics, debt service obligations, and asset values.
As interest rates rise, the cost of borrowing increases significantly. Monthly payments for everything from auto loans to mortgages have risen dramatically since just a couple of years ago, leading to various consequences.
Homeowners with fixed mortgage rates of 2.65 percent now find it hard to sell their homes. Businesses that relied on borrowing for short-term expenses now struggle to manage debt servicing with the higher interest rates.
Growth strategies that were feasible at a 3 percent interest rate now falter at 6 percent, leaving barely sustainable profit margins unable to fill the gap.
Ultimately, rising interest rates exert downward pressure on asset prices. Already, this trend is apparent in the bond market, where prices move inversely to interest rates.
For example, the iShares 20 Plus Year Treasury Bond ETF, TLT, now trades at $82.77, down from a high of $171 in July 2020, marking a decline of over 51 percent. This represents the worst bear market for Treasury bonds ever recorded.
Moreover, both stocks and residential real estate appear significantly overvalued. As interest rates remain high, these assets are likely to adjust downward in response to increased borrowing costs. The fluctuations, however, will not mirror the uniformity of the Treasury market adjustments.
Wouldn’t It Be Nice?
Beyond simply lowering asset prices, the rapid flux in interest rates is generating a host of other implications. The Fed’s policy of cheap credit from 2009 to 2022 propelled individuals, businesses, and governments to accumulate staggering amounts of debt.
Today, in this climate of rising interest rates, many face escalating difficulties; delinquencies on auto loans, credit cards, and consumer loans have reached their highest levels in a decade. As these payments are missed, stress mounts within the banking system.
The risk of a growing number of bad loans could eventually overwhelm the good. Increased debt defaults heighten the chances of a significant banking crisis.
Even if debts are repaid, the extreme fluctuations in interest rates have severely impacted bank balance sheets. Peter Schiff, CEO of Euro Pacific Capital, Inc., recently highlighted the situation at Bank of America, tweeting:
“In the first half of the year, Bank of America recorded pre-tax income of $48.1 billion yet ignored a staggering $95.9 billion in losses on its ‘held-to-maturity’ securities. So, it actually lost $47.8 billion, putting it in worse shape than during the 2008 bailouts.”
As rates continue to climb, bond prices plunge. Bank of America, along with many large financial institutions, is holding onto bonds that have lost significant value. Selling them would incur heavy losses similar to those reflected in TLT’s decline—illustrating the precarious situation of many banks.
What the future holds remains uncertain. Perhaps inflation will stabilize, or interest rates might lower, easing the burden of debt across the board.
As Brian Wilson famously mused, “wouldn’t it be nice?”
Indeed, preventing a major banking crisis would be a relief. It would also be delightful to have leadership that prioritizes the nation’s well-being.
Everything’s Spooktacular
President Biden is a seasoned politician, known for making tactical decisions aimed at enhancing his political standing.
Unfortunately, Biden’s choices often do not align with the best interests of the populace. A recent decision, for instance, involved depleting the nation’s strategic petroleum reserve (SPR).
The SPR was intended as a buffer against supply disruptions, yet Biden resorted to using it for political advantage, notably releasing oil prior to the 2022 mid-term elections to lower gas prices and aid his Democratic colleagues.
Currently, the SPR holds about 351 million barrels of oil. When Biden took office in January 2020, that figure was 638 million barrels, indicating that he has drained approximately 45 percent of the emergency supply for non-emergency purposes.
This reserve was originally established in response to the Arab oil embargo of 1973-74, which was a reaction to U.S. support for Israel during the Yom Kippur War, resulting in soaring gas prices and long lines at pumps. In 1975, Congress created the SPR to prepare for such crises.
Now, half a century later, with another conflict in Israel, Biden’s political maneuvers have left the SPR at its lowest levels in 40 years, significantly weakening the nation’s preparedness for supply disruptions.
On October 6, the day prior to the Hamas attack, the price for a barrel of West Texas Intermediate (WTI) crude oil was $82.79. By October 20, it had risen to $89.16—an increase of roughly 7.69 percent, suggesting the market is slightly on edge regarding potential oil supply disruptions. In response, Biden has lifted sanctions on Venezuela concerning oil.
Additionally, since October 6, the price of gold has climbed from $1,820 per ounce to over $1,974 per ounce—a rise of approximately 8.46 percent. What unease is gold pricing in?
War, famine, pestilence, banking crises, market downturns, complete societal collapse… what will come to pass?
Remember, the month is still young. With Biden in charge, everything is undoubtedly spooky.
[Editor’s note: In this unpredictable landscape, unconventional investment strategies are more essential than ever. Learn how to safeguard your wealth and protect your financial privacy with the Financial First Aid Kit.
Sincerely,
MN Gordon
for Economic Prism
