Why I’m So Worried About the Economy

You’ve read my concerns about the inverted yield curve (that’s when short-term interest rates are higher than long-term rates) and how an inverted yield curve has threatened the economy and stocks in the past. Today, I want to touch on an event that will occur in the next couple of months that few analysts and economists are talking about–even though it could have severe ramifications for investors.

An increase in the U.S. Federal Funds Rate in July to 5% from the current rate of 4.75% is almost a sure thing bet. The Fed itself has told us it’s not finished raising interest rates yet. The number of analysts predicting the Fed’s central bank rate will go to 5.25% by the end of the summer continues to increase.

Here’s the big problem: The bellwether 10-year Treasury Note is yielding only 4.94% as of this morning. If the Fed raises its central bank rate to 5.25%, the Federal Funds Rate itself will be higher than the 10-year Treasury Note yield. In past history, 80% of the time, when this rare inverted yield has happened, the U.S. has fallen into a recession. Most recently, this phenomena (the Federal Funds Rate above the 10-year T-note yield) happened in the spring of 2000–less than one year later the U.S. was in recession.

Fed Chairman Bernanke is playing down the relationship between the Fed rate and the yield on 10-year Treasury Notes. Bernanke says the inverted relationship does not mean a slowdown in the economy lies ahead, instead he says the event means inflation is in check.

With jobs being created and economic growth humming along, I can’t find one analyst that’s predicting a recession ahead. The spiraling U.S. deficit, the ballooning trade deficit, rising gold and oil prices, fifteen interest rate hikes in a row, a cooling U.S. housing market and a U.S. dollar only supported by higher interest rates–am I the only one worried about these items? Am I the only one who believes they are recipe for future economic disaster? I guess so.

My dear reader, don’t let inexperienced analysts and economists (many today who have never really lived through a bear market) convince you the economy is fine, because it’s not. Inverted yield curves happen for a reason. This is an opportune time to start protecting your investment portfolio against a market and economy that could swing quickly (and unexpectedly by most) in the wrong direction.