If I have one non-consensus fundamental theme that I believe is a great trade, it’s that the Fed funds rate isn’t going to get as high as people think.
The market is obsessed with the timing of the first hike when it should be obsessed with the terminal rate of Fed funds.
Fed and private forecasts both see a rate hike cycle starting sometime near the middle of next year and continuing through 2017 to somewhere near 3.00-4.00%. I think that’s absurd.
Right now the US can barely produce any growth with the Fed printing non-stop and coming out of a recession. That’s with China and most emerging markets humming along and no real signs of crisis anywhere. No one is about to wake up and start building factories in the US and hiring millions of workers.
But what really gets me is the timing. Starting in about 2017 the demographics in the US (and other developed countries) really start to take a dive. Baby boomers are going to be retiring, labor force participation dropping and there will be tremendous strains building on government finances. The worst part is that not even the biggest optimists have any hope of Congress taking action.
Marketwatch takes a look at the spending costs that will hit.
The deficit will began growing faster in 2018, as more baby boomers retire, putting added pressure on Medicare, Medicaid and other entitlement programs. As we all know, neither Democrats nor Republicans have the will to trim these third-rail behemoths in a substantive way, meaning this: no matter what the government spinmeisters say, entitlements (programs for the elderly and disabled already gobble up two-fifths of all federal spending) will further squeeze non-discretionary programs.
More likely than the Fed going into 2018 with 4% rates is the US economy going into a long, inescapable recession that year. If not, the Bond King sees 2020 as being the year when it all starts to fall apart.
