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  1. Home
  2. / Investing
  3. / U.S. Equity

Fed Rate Hike Will Prime the Money Pump

But that doesn't mean you should unload gold, commodities and stocks.
By MIKE NORMAN Jul 21, 2015 | 02:00 PM EDT

We're probably in the eighth or ninth inning of the commodity selloff. I truly believe this. You see gold's plunge the other day and commodities so weak at 13-year lows? The gloom and doom and pessimism are everywhere. What a reversal from the euphoric commodity outlook of a few years ago.

The reasons behind the commodity selloff are pretty simple: overspeculation and a fundamental story line that never really supported the rise. The overspeculation was pretty obvious, it was everywhere. From TV commercials telling everyone to go out and buy gold and cold coins, to gold-mining reality TV shows to everything else in between. And who could forget the talk of $200 crude, remember that?

These false story lines were something I covered in frequent detail here on Real Money. Of particular focus were my attacks on all the misguided talk of central bank money printing. In fact, that was never going on. What was going on was the removal of hundreds of billions in interest payments from the private sector as rates were lowered to zero and kept there.

On this latter point, I believe we are about to see the story change. It's why I am turning more constructive for the long term. Think about it. When the Fed raises interest rates -- now thought to be in September -- that will set the fiscal money pump in motion.

I'll give you an example to explain what I mean. Let's say the Fed raises the Fed funds rate from zero to 25 basis points, which will almost certainly be their opening salvo. That increase will ripple out along the curve, and rates will climb at least as much if not more the further out you go.

Consider the fact that there is $18 trillion worth of securities outstanding. The holders of those securities earn interest. An increase of 25 basis points on $18 trillion in debt equates to a fiscal injection of at least $45 billion. That's $45 billion of additional government spending, annually.

Now consider this: The current yield on a two-year Treasury is roughly 0.7%. In other words, the Treasury market is predicting that two years from now the Fed will have put through something on the order of three rate hikes of 25 basis points each. On $18 trillion in debt outstanding, you are talking about a fiscal injection of $135 billion over two years, if that happens. That's a very meaningful stimulus.

Just as the quantitative easing and the other Fed measures, rate cuts, etc., helped take money out of the economy, this will be doing the opposite. This is once again turning the spigot back on.

In fact, what I am describing was Ronald Reagan's economic formula, although he called it supply-side economics, but in reality this is what it was. By pursuing huge tax cuts and defense spending increases, the deficit under Reagan surged and that meant more interest payments on the debt. Interest became the largest line-item expenditure under Reagan.

The same thing is going to happen again when the Fed starts raising rates; however, the first reaction by investors is going to be to sell gold and commodities and stocks. That will be a mistake.

I want to tell you what else will reverse. That's going to be the dollar. The Fed's QE removed billions of dollars from the economy and created a multiyear-long short squeeze. However, raising rates will put those dollars back. Those interest payments will constitute a net increase in dollar flow from the federal government to the economy, causing the dollar to reverse the gains it has achieved over the past five years.

We're very close now, very close. Be patient and once the Fed starts you will have your next two- to five-year trading plan.

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At the time of publication, Norman had no positions in the stocks mentioned.

TAGS: Investing | U.S. Equity

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