Amid the racket made by plummeting interest rates in the US, it is a quite astonishing fact that the Fed has actually lowered interest rates only once in the past eighteen months. The intended Fed Funds rate was lowered by 0.25% to 1.75% on December 11, 2001. The only subsequent lowering was the 0.50% cut to the present level of 1.25% on November 6, 2002.
Here are some of the things which have happened on the markets since November 6, 2002:
You will note that the rise in the $US Gold price and the fall in the $US index are quite close in percentage terms. But what stands out in this data is the HUGE falls in Treasury yields over the seven months since the Fed last cut rates. The REAL eye opener is that the vast majority of these falls in Treasury yields has taken place in the two weeks since the beginning of June.
Here's the data on that - the yield falls since June 2, 2003:
We pointed out in our previous Gold commentary that REAL official rates in Japan, the US, and Europe were all now either negative or zero. That has not fazed anyone, not yet anyway. The whole world (ourselves included, we hasten to add) is absolutely SURE that the Fed will cut rates at the next FOMC meeting on June 24-25. Mr Greenspan would not DARE not cut rates.
On top of this, the Fed has repeatedly stated since they last cut rates in November 2002 that even if the Fed Funds goes to "zero", they can still keep the liquidity in the system "topped up" by buying Treasuries of longer and longer maturities and by branching out into the corporate debt market. There is evidence that they are already doing this. If Treasury yields, especially shorter-term Treasury yields, keep falling at the rate they have been falling so far this month, they will be pricing in a 0.50% rate cut before the Fed actually meets. The "consensus" is for a 0.25% cut to 1.00% but there are several more hopeful pundits who are suggesting that a 0.50% cut might be on the cards.
Please remember, in this context, that the Fed has cut interest rates TWELVE times since they began their rate cuts in January 2001. Eleven of these twelve cuts took place in 2001 - WHEN THE $US WAS STILL IN ITS POST 1995 BULL MARKET. There has only been one rate cut since, the one in November 2002. This (0.50%) rate cut had two big consequences. First, it pushed the $US index below the trendline which had supported its post-1995 bull market and CONFIRMED a $US bear market. Second, it led directly to a two month (December 2002-January 2003) $US 60 leap in Gold.
All that took place only six months ago, but it seems to have been entirely forgotten. How else can one explain the STAMPEDE into Treasury debt which has been THE market phenomenon of June 2003? It is true that the rush of "liquidity" into Treasuries has accelerated since the reports of financial hijinks on the books of the main government mortgage makers (those supposedly "bullet proof" Government Sponsored Enterprises or GSEs - the Freddies and Fannies) came out earlier this month. Nonetheless, what we are now witnessing is a lemming like stampede into the last refuge of what is called the "safe havens". SAFE HAVEN!? With interest rates approaching ZERO in nominal terms and already BELOW zero in REAL terms? In paper donominated in a currency which is in a BEAR market, which has been steadily falling for eighteen months, and which promises to fall faster and harder at any minute? The mind truly boggles.
One must go back more than 20 years, to the end of the 1970s, to find the last time that the rest of the world and Americans themselves were running away from US Dollars and all investment instruments (including Treasuries) denominated in US Dollars. Everybody knows that as the yields on debt paper goes down, the capital value of the paper goes up. The US bond market is in a bubble, but unlike the stock market, there is an answer to "how high is up". Yields cannot fall below ZERO in nominal terms, and as far out as five years on the yield curve, that leaves very little "room for improvement" left.
We have a situation in which the faster Treasury yields head towards their ultimate low, and the Treasury debt bubble its ultimate high, the more money is poured into them. Lemmings have got nothing on Wall Street these days.
Right on cue with the acceleration of the bond bubble, Gold took a hit this week when it fell $US 9.60 to $US 352.20 on June 10. The monetary mechanics at the Fed and the Treasury and on Wall Street are painting themselves into a corner. They have almost no room for manoeuvre left. To maintain the structure of the system, it is ABSOLUTELY MANDATORY that ANY potential "escape route" from paper assets be debunked. Hence Gold's fall, in the face of plummeting interest rates and a falling currency.
For almost a year, between December 2001 and November 2002, the Fed hoped that it could hold the line. It found that it couldn't, so it had to cut again in November 2002. That cut heralded the start of the Fed's warnings about "deflation", just in case their manoeuvre room on interest rates ran out. The acceleration downstairs of the $US and upstairs of the $US Gold price right after that November 2002 rate cut scared them green.
Had it not been for the distraction of the Iraq war, the Fed would probably have cut rates again at their March 18 meeting (remember, the Iraq war began on March 19). The war bought them three months. Now, another rate cut is a CERTAINTY. How anyone can seriously entertain the thought that this cut will "succeed" where the previous twelve failed is utterly beyond us. But then nobody wants to look beyond June 24-25 right now.
Remember, while Gold has resistance and support points, and is the most deadly enemy of the paper mechanics, it has no "ceiling". Bonds do have an absolute ceiling, a nominal interest rate of ZERO. One should not be surprised that the Fed has repeatedly "reassured" the markets that they will buy Treasuries "if necessary". At or near the ZERO rate level, who else would do so?
After the rate cut at the FOMC meeting on June 24/25, with the Fed Funds rate at 1.00% (or possibly 0.75%), the Fed will be left staring into the eyes of what has always been their ultimate nightmare, the necessity of having to MONETISE US Treasury debt issuance.