Will Trump Fire the Fed?

Karim Rahemtulla By Karim Rahemtulla, Options Strategist, The Oxford Club

Credit Trends

Managing Editor’s Note: The article below comes from The Oxford Club’s brand-new Options Strategist, Karim Rahemtulla. We’re excited to welcome Karim to the Club and pleased that he’ll be joining Wealthy Retirement as a Contributing Editor moving forward.

Leave a comment or send an email to mailbag@oxfordclub.com to let us know what kinds of alternative income strategies you’re eager for Karim to cover… And make sure to look out on Thursdays for his weekly Wealthy Retirement columns.

We’re in interesting times. The U.S. economy is growing, albeit at an anemic rate.

Meanwhile inflation, the bane of all savers, is inching higher. And it may move significantly higher in the years ahead.

Inflation reduces the spending power of each dollar you have as prices of goods and services increase at a faster rate than that of the value of your savings.

We’ve had almost a decade of zero interest rates, meaning that savings growth outside of contributions has been close to zero.

This has forced almost everyone I know to move money into assets like stocks, bonds and real estate because the returns have been greater than holding on to cash.

Those with money (and a decent job) have been on a major shopping spree.

And each time they’ve bought something like stocks, they’ve been handsomely rewarded as the market’s been hitting new highs daily.

The party would normally be in danger of ending after so many years of upward movement without any significant correction to speak of. But this party just doesn’t want to end right now.

Stocks look overvalued by a number of historical measures: price-to-earnings, earnings growth, even price-to-book value in sectors like technology. But we’ve never had such a prolonged period of zero interest rates either, so valuations were bound to expand.

The Federal Reserve, the group assigned to spoil the party, is telegraphing higher interest rates ahead. They’re seeing what I’m seeing.

Subprime auto loans (issued to those with credit scores below 660) are dangerously high, approaching the peak level of 2009. People are feeling good enough to buy cars they can’t afford.

The chart below shows that those with subprime FICO scores are beginning to get loans at a greater pace than they were when the market was at its frothiest levels back in 2006, 2007 and just before the crash.

In many areas, home prices have moved well past the peak levels of 2006 and 2007. Bidding wars are normal and banks are loosening credit.

While retail sales at brick-and-mortar stores are down, that’s not the case for online sales. During the last holiday season, they easily surpassed those of brick-and-mortars.

Airplanes are full, highways are packed and concerts tickets – priced higher than the paychecks of those attending – are selling out.

Where’s the money coming from? Credit.

Consumer borrowing is at all-time highs. Zero percent credit card cash transfer offers are back, and banks are once again offering loans with as little as 3% down.

This suggests trouble ahead. And early signs are coming from the auto sector. As the chart below shows, delinquency rates are beginning to rise again.

But in the face of a rising chorus for the Fed to raise rates ahead of inflationary pressures, we have a White House that, long term, favors lower rates to stimulate growth in business spending and employment.

The Fed and the White House are at odds on the direction and velocity of interest rate hikes. And this is setting up a potential conflict between Federal Reserve Chair Janet Yellen and Donald Trump.

Remember, the Fed chair serves at the pleasure of the president for a four-year term. The president can also “fire” him or her.

Yellen is on course for at least three rate hikes this year, maybe four. The first is on tap for the middle of this month. If the economy is growing like gangbusters, that shouldn’t be an issue.

But if GDP remains at an annual rate below 2%, the Fed could plunge the U.S. into a recession by tightening our money supply too quickly.

Capacity utilization is the number I like to look at.

Capacity utilization measures how much slack there is in the economy versus what output could be. The closer the number is to 100, the closer it is to full capacity utilization.

As you can see below, industrial capacity utilization is trending lower again after a spike when our economy emerged from the Great Recession. We are nowhere near that number or even precrash levels.

In order for the country to embark on a path of higher growth, this trend has to reverse higher. Lower utilization is a sign of economic weakness.

This year may prove to be the most volatile in a decade for fixed-income investors.

Those looking for higher rates may have their way in the short term, but if higher rates lead us into a recession, that euphoria will be short-lived indeed.

Here’s the upshot: If you’re in the market for a car, new or used, you’ll get a better deal as delinquencies continue to pick up and cars are repossessed. Higher rates also dampen auto sales. So if a new or used car is on the horizon, try to stick it out with what you have for a few more months.

If you’re a fixed-income investor who’s been waiting for rates to move higher, the next 12 to 24 months may represent the best opportunity in a decade to lock in a higher rate. As inflation numbers head higher, so will interest rates.

But the odds are pretty high that if rates move too high too fast, the economy will face a recession again, and that will mean a return to a zero interest rate policy.

Good investing,