From the monthly archives:

October 2015

In the investment banking universe, there’s no more contentious issue than Federal Reserve policy.  This week’s interest rate decision will be no different.

On Wednesday, the Federal Reserve is set to announce its decision on the Federal Funds target rate.  Unless the Fed shocks the world, and with Janet Yellen at the helm that’s a very unlikely scenario, the Fed will keep the target rate where it’s been for the past over 8 years.  The rate is currently set at between 0% and 0.25%.

The incredibly loose Fed presents an interesting question.  Which of the following two will jump up first?  Will the Fed increase its holdings of Treasuries or will it raise the Fed Funds target rate?

First, a Look at the Treasury Holdings

The following graphic is a look at Treasury holdings of the Federal Reserve from 2003 to 2015’s most recent figure.  Over this period, there have been 3 jumps in Treasury holdings and 1 drop.

Addressing the drop first.  From November 2007 to June 2008, the Federal Reserve’s holdings of Treasury securities declined by about $300 billion to ~$480 billion.  The drop stemmed from the onset of the global financial crisis, with the Fed selling assets to individuals looking for safe harbor securities.

Next, the 3 jumps – which all occurred for generally the same reasons.

The first jump occurred from March to September 2009, with the Fed’s holdings expanding by almost the $300 billion it sold the prior year.  The purchases occurred as an attempt to lower long-term borrowing costs and encourage economic activity.

The second jump began in August 2010 and lasted to October 2011.  Over this period, the Fed’s holdings exploded by almost $1 trillion, to $1.7 trillion.

The third jump lasted the longest, from December 2012 to October 2014, with the Fed purchasing another about $800 billion in Treasury securities.

Overall, the most recent accounting has total Federal Reserve Treasury holdings at $2.464 trillion, about $1.7 trillion above where it was prior to the global financial crisis.

Treasury Holdings of the Federal Reserve

Second, a Look at the Fed Funds Target Rate

The following graphic is a look at the Federal Reserve loosening cycles since the 1970s.  A loosening cycle begins when the Fed starts lowering interest rates, and ends when the Federal Reserve starts raising interest rates.

As indicated, the current cycle isn’t exactly a short one.  To the contrary, the current loosening cycle is about 3,000 days long, much longer than the previous longest loosening cycle that began in 1989 and ended in 1994.  This cycle lasted about 1,700 days.

Loosening Cycles by Start Year

So, Which Comes First?

The question regarding which comes first depends partly on the state of the American and global economies and partly on the personalities in charge of Federal Reserve policy.  Given that global economic conditions are generally weak, and the sitting chairwoman of the Federal Reserve has a large bias towards loose monetary policy, it’s a reasonable bet that the Fed starts buying Treasury securities before it begins addressing much needed normalized Federal Reserve interest rate policy.


The Federal Reserve is set to announce an interest rate decision on Wednesday.  Unless the financial world is caught completely off guard, it is likely that the Fed will leave the Federal Funds target rate exactly where it is, and where is has been for 8 years.

The incredibly loose Fed raises an interesting question, especially in light of chairwoman Janet Yellen’s bias for loose monetary policy.  Which will happen first – Will the Fed enter another round of Treasury hoardings, or will the Fed begin to raise interest rates?

Although the baseline presumption among economists is that a rate hike is pending, there’s a good deal of reason to believe that more money printing to buy Treasury securities will be the next step of the Federal Reserve.

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Although always in a backhanded manner, the price of gold is intricately connected with inflation and thereby indirectly with the investment banking world.

Overall, since bottoming on September 11 at $1,100 per troy ounce, gold is up about 5% to about $1,152 per ounce.

Interestingly, gold is gaining strength during a time when inflation – typically thought of as the driver of gold prices – has been trending down, perhaps even moving towards actual deflation in Europe, the U.S., and possibly China (China probably not, although it is possible).

Price of Gold, Sep. 2015 - Oct. 9, 2015

inflation global

The disinflation or movement towards deflation presents a conundrum for (mainly) European and American central bankers.  Mr. Draghi, Ms. Yellen, and their likeminded advisors have long been attempting to manufacture inflation, but to no avail.  They have tried printing money, buying bonds, avoiding raising rates, and sending messages that they have no intention of raising rates anytime soon.  None of these actions have worked.

The answer as to why massive government printing has not led to significant inflation lies in a complex web of deleveraging, demographic forces, weak business loan demand, and globalization.

So, What Could They Do To Manufacture Inflation?

With the aforementioned as the background, what could American and European central bankers do to manufacture inflation quickly? The answer: buy gold above market rates.

Essentially, the American and European central banks could announce that they are going to buy gold at say $4,000 per troy ounce. That would be a massive depreciation of the euro and dollar relative to gold.  And, all other prices would need to follow suit.

In order to keep price parity, the price of oil would rise to $350 per barrel, and other prices would summarily follow suit (at least theoretically).

Seem preposterous?

Well, the American Federal Reserve has done it twice before to boost inflation.

The first time was in 1933.  President Roosevelt announced that the American federal government would buy gold at $35 per ounce, a 75% jump from the $20.67 per ounce it was paying up to that point. The action contributed to a break in deflation.

The second time was in the 1970s, when President Nixon and the Americans moved the other way.  Nixon announced that the U.S. would no longer convert dollars into gold with major trading partners. Gold went on a tear, gaining over $2,200% over the next nine years.  Inflation followed suit, with price inflation in the U.S. reaching double digits in the early 1980s.

So, central bankers, most notably the Americans, can make moves to quickly turn deflation into inflation. When governments around the world decide to do this, one can certainly expect gold to appreciate materially, as it did before.


Overall, could central bankers attempt to quickly turn prices from deflation into inflation? The answer is certainly yes, as they have done before.

Although gold investors would not be intentionally targeted, they would be massive beneficiaries of central bank policy.  It has happened before; it can happen again.

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