In May of 2004, the federal funds rate, the bellwether rate upon which all interest rates in the U.S. are based, was one percent. The Federal Reserve, sensing the economy was getting overheated, started raising interest rates quickly. Three years later, by May 2007, the federal funds rate was 5.3%.
Any way you look at it, the 430% rise in interest rates over a three-year period killed stocks, real estate, and the economy.
My studies show the Federal Reserve has historically taken things too far when setting its monetary policy. It raised interest rates far too quickly in the 2004–2007 period. And I believe it dropped rates far too fast since 2009 and has kept them low (if you call zero “low”) for far too long.
In the same way investors suffered in 2008–2009 as the Fed moved to quickly raise rates, I believe we will soon suffer as the Fed is forced to quickly raise interest rates once more while the economy overheats.
It’s all very simple. The U.S. unemployment rate is getting close to six percent. The real inflation rate is close to five percent per annum, and the stock market is way overheated. The Fed will have no choice but to cool what looks like an overheated economy. But the Fed won’t be able to do it with a quarter-point increase in interest rates here and there. It will need to raise rates by at least two to three full basis points.
The Federal Reserve itself told us last month it plans to increase interest rates by more than two percent by the end of 2016. I believe the rate increase will have to come a lot quicker than that.
The Fed is predicting a federal funds rate of 2.5%. Under that scenario, stocks will not be attractive, investment real estate will fall in price, and gold will rise. Unfortunately, due to all the inflation the Fed has created by printing $4.0 trillion out of thin air, interest rates may have to move a lot higher and quicker than the Fed currently predicts. Investors should adjust their portfolios accordingly in advance of the higher rates headed our way.