November 21, 2016
The Real World and Interest Rates
As I have been writing since the election, the economics of the USA, and really, the rest of the planet, have been dynamically changed, literally overnight, since the TOTALLY unexpected Trump AND Republican Congressional victories…And as I have also noted, I think we are about to see more spending and economic stimulating than this country has seen in decades.
Here are some follow-up thoughts regarding what I think the impacts of these ramped up policies to “build everything in sight” will be as we head into 2017…and beyond.
On January 3rd, the new Congress will convene amid an atmosphere in which I believe virtually every Congressman in Washington will be racing to dip their hands in the Federal appropriations pot and take relatively massive projects back to their constituents…and I think they will begin doing so IMMEDIATELY…with the first call to order…Whether they be Republican or Democrat, they are unanimously going to open up the funding spigots (with the idea that a ramped up economy will produce the necessary revenues to pay for everything further down the road) and they will NOT be waiting until later in the year to do it…No, not a chance…This will NOT be small ball. And everybody will be grabbing as much as they can…as fast as they can…and my guess is, no representative will be questioning what any other representative is asking as they all come up with “essential” projects for their own communities. And I reiterate, they will most likely be diving in straight out of the gate in January, NOT next November…And to top it all off, this will all be accompanied by Trump’s inauguration several weeks later, when we will undoubtedly be hearing the 2017 new administration version of, “What we want to accomplish in the first 100 days”, which will certainly serve as even more of an inspiration to, “Build Baby Build!” And how to we do it? “Spend! Spend! Spend!” For sure, there will be a few guys preaching fiscal restraint…but they will be totally ignored by this legislative mob rushing to grab every dollar they can…temporarily shedding their conservative financial principles…while everybody else, whatever their political party, is doing exactly the same thing…It’s human political nature…If everybody else is getting some, I want mine too…
But then…what happens in the real world?
Let’s say a single Joe Blow secures funding for $50,000,000 towards roads and bridges in his district…The first thing that happens is the congressman (or the local powers that be) select and grant contracts to numerous individuals or companies for the various aspects of planning, designing and completing the projects…And the next thing those contractors ALL do, BEFORE they go to work, is GO TO THE BANK AND BORROW THE MONEY THEY NEED TO START, AND FINISH, THEIR PART OF THE JOB…
And that is what this is all about…THAT THE GOVERNMENT DOESN’T PAY UP FRONT…WHICH THEREFORE MEANS THAT EVERY PROJECT THAT GETS APPROVED BY CONGRESS MOST LIKELY WILL MEAN SOMEBODY GOING TO THE BANK FOR FINANCING…AND WITH EVERYTHING WE’VE HEARD FROM TRUMP…AND WITH FACT THE REPUBLICANS (AND DEMOCRATS) WILL BE ABSOLUTELY FOLLOWING HIS LEAD…I THINK WE ARE GOING TO SEE A BUILDING/SPENDING FRENZY…
AND WE ARE GOING TO SEE GOVERNMENT “INSPIRED” LOAN DEMAND LIKE THIS COUNTRY HAS NEVER SEEN BEFORE…WHICH, IN MY OPINION, CAN ONLY MEAN “DECIDEDLY” HIGHER INTEREST RATES…BOTH SHORT TERM AND LONG TERM…IT’S NOT COMPLICATED…WHEN BANKS HAVE GOT PEOPLE BEATING DOWN THE DOORS TO BORROW, THE PRICE OF MONEY GOES UP…ALMOST IRRESPECTIVE OF WHAT THE FED IS OR ISN’T DOING.
On another front…Simply stated, I also do not see how all this ramped up building can do anything other than result in higher commodity prices. Same as all that previously unanticipated loan demand, NOBODY in the commodity producing world has been preparing for a surge in commodity demand…and the fact is, we have already seen some commodities, like Copper for one, jump sharply since the election…With this in mind, I have no idea as to how big the price impact of all this “stimulation” will be, but one thing I DO know is it WON’T be bearish for prices…which leads me then to conclude that WE ARE MOST LIKELY GOING TO SEE SOME HIGHER DEGREE OF INFLATION THAN ANYONE, INCLUDING THE FED, WAS PLANNING FOR…AGAIN, JUST TWO WEEKS AGO…
AND TOO MUCH INFLATION ALMOST CERTAINLY WILL MEAN HIGHER INTEREST RATES. With the Consumer Price Index currently running at about 1.6%, with what I think could easily be described as an EXPLOSION IN BUILDING AND CONSTRUCTION, the possibility of having posted a 4-5% annualized inflation rate…by late next summer…seems like a VERY real possibility to me...And if we do have 4% inflation, I’d say there is also the very real possibility of seeing short term rates EASILY hitting 3-4% as well…which is, yes, substantially higher than I was predicting just one month ago….But after all, just as none of those congressmen is going to be waiting until late 2017 to grab the money, the markets will not be waiting until late 2017 to make price responses either…Bottom line is, I THINK THE FIRST 6-9 MONTHS OF 2017 ARE GOING TO BE GANGBUSTERS…IN ANY NUMBER OF MARKET AREAS…AND I DON’T THINK THE RESULT CAN BE ANYTHING BUT INFLATIONARY…AND THAT WE WILL EASILY SEE SOME “BAD” NUMBERS START TO APPEAR WELL BEFORE WE GET TO MIDYEAR.
AND, AS I HAVE BEEN SAYING, THE INTEREST RATE MARKETS WILL MOVE AHEAD OF THE FED. And this is happening…Think about it…Both short term and long term rates ARE already moving up and we STILL have not had an official raise in rates from the Fed….but I would be honestly blown off this chair if they DON’T make a move at their December meeting…Same as everyone else, NONE of them were expecting the Trump-Republican victory and NONE of them were expecting the ramped up stimulus that is dead ahead in 2017…And at least some, if not all, of them are thinking along exactly the same lines as I am expressing here…Believe me, there are at least a few of those guys who KNOW that “a gradual move up in rates” may NOT be enough to cut it…And all of them, Yellen included, will readily admit that the Fed DOES sometimes MISREAD what is coming in the economy…They DO find themselves having to play “catch up”, and that is precisely where I think they are now…This Trump inspired, “Build it and they will come” thing, is not some 4-5 month phenomenon…The Fed is NOT just going to make a few token quarter percent raises and then have everything settle back down to a nice and quiet economy….NO WAY…Rates are going up…and a lot…and for at least the next few years…My opinion anyway.
I CONTINUE TO BELIEVE RATES HAVE BEGUN TO MOVE SHARPLY HIGHER AND I CONTINUE TO RECOMMEND BUYING PUTS ON EURODOLLARS.
Here is the option I am buying at current levels…
Honestly…To me, a move to 98 DOES look easy…and NORMAL for this market….
And I get the same impression when I look at the long term…
The Dow and S&P 500 both closed into new all time highs today…I am still seeing countless Wall Street brainiacs preaching caution, and “It’s overbought”, or “It will correct”, “Wait for the pullback”, etc., essentially the same wrong way, negative, BAD ADVICE sort of stuff they have spouted all year…NONE of them were buying the market ahead of the election…and my guess is none of them have bought it yet…
I CONTINUE TO BELIEVE THE STOCK MARKET IS IN AN ABSOLUTE LIFT OFF MODE…SIGNALING WHERE THE ECONOMY WILL BE SIX MONTHS FROM NOW…AND CONSIDER THIS TO BE JUST ONE MORE REASON WHY RATES WILL KEEP CLIMBING…AND EURODOLLARS WILL KEEP FALLING.
The truth is, I don’t think a damn thing has really happened yet in Eurodollars…that all they have done is confirm the top…and confirm that interest rates ARE on their way higher…I mean, we haven’t even seen an 8-10 tick down day yet...which I think will become the norm…and I DO, every morning, turn on this machine expecting to see just that sort of action…The point is, I believe it is absolutely not too late to get on this thing…to either put on an initial position or to add to an existing one…and that IS exactly what I recommend here.
If you think all this makes sense, and you have the risk capital…and temperament to be involved with this…I encourage you to pick up the phone and call me.
Here’s another look at the option I like here…
All option prices in this newsletter include all fees and commissions.
The author of this piece currently trades for his own account and has a financial interest in the following derivative products mentioned within: Eurodollars