Producer prices are now rising at the fastest pace in two years. When OPEC did the oil deal last month, I said that it would drive up crude and ignite further inflationary pressures. We see in the PPI this morning that those pressures had already been building. This will certainly put the Fed in play for a December rate hike. The CME Group's Fedwatch Tool now shows a 63.6% chance of a hike.
This alone will be all the Fed needs to have the "confidence" to make the move as if confidence is needed by a monopolist. Yellen and her team don't seem to understand this, as they continually look to "the markets" for guidance on what to do. So did Bernanke. I recall one time when his Fed was considering another round of Quantitative Easing and they asked market participants -- they literally polled market participants -- what quantity of Treasury securities did they think the Fed should buy. That would be like John D. Rockefeller asking his tiny, meek, competitors how much oil they thought he should sell and at what price.
Monopolists don't need to ask anyone how much and at what price. They dictate the terms. And that's the key thing here. The U.S. and its bank, the Federal Reserve, is a monopolist in its own currency, the U.S. dollar. I've been all through this before, but there is really no reason at all that the U.S. pay interest on its own money or, for that matter, even issue securities at all. Issuing securities functions only as a reserve drain and now that the Fed pays interest on reserves directly there is no need to issue securities at all.
Remember all the people who were crying that when the Fed raised rates there would be this avalanche of Treasuries that they would have to unload? Well, guess what? The Fed did raise rates last December and their Treasury holdings are above what they were a year ago. So, there you go. There was no avalanche and there won't be.
The payment of interest is a fiscal injection to the tune of about $250 billion annually. That is what the U.S. government paid out in interest on Treasury securities last year. And by the way, about $33 billion of that went to the Fed, since the Fed holds about $2.4 trillion of government securities. Then the Fed just turns around and gives that money back to the Treasury. Ridiculous. A charade. The whole thing is comical. The real point is, the $250 billion would probably be better spent by making investments that we need: rebuilding infrastructure, more schools, basic science and r&d, etc.
Inflation will continue to pick up and once the Fed starts raising rates again, you will see it climb even faster. Many people will see this as a killer for the markets and the economy. Not me. I will see it as further fiscal injection. Stocks will rise, as will risk assets like gold, commodities and foreign currencies. The dollar and Treasuries will head lower. This is how it works. You fade the initial reaction by investors who will be doing the opposite on the belief that rate hikes quell inflation and create a drag on the economy.
The good news is that I still see a lot of pessimism. The level of worry is high. There's Deutsche Bank (DB) and Brexit and the Fed and China. All these things are meaningless. We should probably all be worrying about nuclear war with Russia; the risks of that happening are rising every day. Instead, you have people going nuts over whether or not Britain's economy will survive as a result of being separated from a sclerotic, badly constructed, highly unstable contraption of a system known as the EU. Dumb.