Video Update: Why the Fed Is Planning “Stealth” Interest Rate Hikes

The Fed just shocked Wall Street… but not in the way you’d expect.

It left rates unchanged.

In today’s video update, Chief Analyst Adam Galas will tell you how this affected the market… an upcoming stress-test of banks… why we could still see higher prices ahead as a certain type of inflation continues… and the Fed’s plan to tame the dragon.

As Fortress Portfolio members, you know we designed this service to thrive under all economic and monetary conditions. But knowing what lies ahead helps us prepare for a future few others are ready for.

Click below to watch the update.

Happy SWAN (sleep well at night) investing,

Brad Thomas Editor, Fortress Portfolio

Welcome Fortress Portfolio members to a very special weekly update: Fortress video number 22.

WTF did the Fed just do?

Now, the Fed just shocked Wall Street, but not in the way you'd expect.

So let's talk about what the Fed does and what it means for the markets and your portfolio.

Now, the Fed just did what Bloomberg describes as a super hawkish skip.

They basically left rates unchanged. But signaled that rates will peak at 5.6% (basically between 5.5% and 5.75% this year).

Now, this implies they're going to hike 25 basis points in July and another 25 basis points in September.

Now, initially, this sent bond yields soaring for a few days, but the stock market didn't react.

It just kept rising until stocks ran out of steam.

Now, why did the Fed skip? Because apparently Powell is worried about banking instability.

Now, next week, the Fed is releasing its annual stress tests on the banks.

But one would imagine the Fed probably has access to this preliminary data early.

So, what is the Fed actually worried about?

Well, it's still worried about inflation. The Fed tracks many metrics of inflation.

And they're still basically pointing to around 5% to 6% underlying inflation.

Unfortunately, it’s not expected to come down very rapidly.

The Cleveland Fed's real time daily updated model shows that core and headline inflation are expected to come down a bit in the next few months, but will still basically be stuck at 4.5% when you annualize the month over month figures.

Now, starting in August, the Fed actually expects that the headline consumer price index (CPI) inflation – the one the media keeps reporting on – is going to start climbing… Possibly for three straight months.

In fact, in September, the Fed thinks that CPI will be about 4%.

That's what it is today. But there's a big difference between today and September.

The longer inflation remains stuck at current levels, the bigger the threat that inflation expectations will get stuck at elevated levels.

That's why the Fed is saying it plans to hike twice more and then keep rates that high well into 2024, possibly into April.

Now, is this actually going to happen?

Well, the bond market is only pricing in one more hike and then cuts starting in January as the economy falls into recession.

In fact, the bond market currently thinks the chances of the Fed actually delivering two more hikes is only 20%.

But here's what you really need to remember. As we talked about last week, the most important thing to the economy are real interest rates.

Now, the Fed says it plans to hike to 5.5% and then keep rates there to around April before cutting.

Well, what that would actually mean for the economy (if the Fed delivered), would effectively be about ten stealth rate hikes within nine months.

Basically, real interest rates going from 1% today to 3.5% at a record clip.

Now, remember that as money leaves the economy currently at a rate of -$300 billion per month — thanks to Treasury bond sales, the Fed, and the resumption of student loan payments — the same interest rate level becomes harder for companies and consumers to bear.

This is the principle of real interest rates, which we covered in detail last week.

Now, many economists, of course, understand this, but what they don't understand is why the Fed is doing.

This seems like pure economic insanity. And, it would be if the goal was to avoid recession.

But that's not the Fed's goal.

The Fed is actually worried about something else. They are worried about stagflation similar to the 1970s.

And like in the 1970s, inflation initially spiked, then came down during a recession.

But then – as the Fed pivoted – inflation bottomed at a much higher level and then resumed climbing.

Inflation expectations went up. Wages then had to keep up with them. And we had a wage price spiral resulting in a decade of 7% average inflation with a peak of 15%.

That is the Fed's number one fear. A second wave of inflation coming off an acceleration of the economy when they start to cut and ease policy.

So the Fed (learning from the mistakes of the seventies) knows that it needs to kill inflation, stone cold dead.

It needs to shoot it in the head, light the corpse on fire, and launch the ashes into the sun.

When it comes to runaway inflation, you cannot mess around. This is the lesson of the 1970s taught to us by Paul Volcker, who was one of Jerome Powell’s mentors.

And this is why the Fed is willing to cause a mild recession today to avoid a severe recession tomorrow, which would be far more painful to workers and our portfolios.

In fact, the Fed's own economists (and it has about 400), say they do expect a mild recession this year.

Though the Fed officially says, “No, no, no, no, no recession,” as one would expect.

Remember, this is partially a confidence game.

So Powell is basically refusing to admit what his own 400 economists are telling him.

Now, look, Jerome Powell is far from perfect. So is everyone on the Fed's Open Market Committee (the people making these interest rate decisions).

Powell after all, in 2021, at Jackson Hole famously called inflation “transitory.”

Well, needless to say, that did not age well.

The very next year (2022), he had to come to Jackson Hole as an inflation slaying, fire breathing dragon who torched the stock market for the next few weeks.

Now, this is why the Fed is working so hard to convince the bond market that it is serious about higher for longer.

After a decade of investors learning that everything is a V-shaped buy the dip opportunity, now the Fed has to fight tooth and nail to actually tighten financial conditions.

Why? Because Americans love spending. It's our way of life. It's practically our birthright.

And I love it to this year. I have been spending more than ever on things I love, such as Chick-Fil-A and charity. I am part of the problem, and that's what Powell is trying to solve.

He wants to minimize the economic damage while preventing 70s style runaway inflation that would devastate the standard of living for tens of millions of Americans.

This is a thankless and impossible task. Literally, 9 of the last 12 recessions were caused by the Fed.

And of the three times the Fed was able to cool inflation without a recession, none of those times did inflation begin above 5%.

Now look, immaculate disinflation (like what so many people are hoping for) is basically a unicorn. It doesn't exist.

Now, could it exist in theory?

Well, sure. I guess if you genetically crossed a horse with a narwhal, you could create a unicorn.

But right now, the Fed is simply trying to follow its most important mission: slaying the inflation dragon before it grows too big and burns all our cities to the ground.

Now, I understand why many people dislike the Fed. They don't trust it. Some even want to see it abolished.

But let me assure you, Jerome Powell is not the devil. I have watched every press conference of his on Bloomberg for two years.

I have watched him testify before the House and the Senate eight times.

This is a man, a Trump appointee, who is the ultimate monetary policy nerd.

His background is not as an economist, but as an investment banker. He worked for the private equity firm Carlyle Group, and was a scholar at the Bipartisan Policy Center for two years after that. He then was appointed to the Fed under Obama, where he served for six years before Trump made him the Fed chairman. And after he was confirmed by the Senate twice.

Now, if you listen to Powell speak, you do not hear the voice of an evil man, or a demagogue, or a tyrant who wants to strip Americans of their rights.

If you can stay awake long enough to actually understand what he believes (because he's about as exciting as listening to paint dry), you will find that he is a pure technocrat, a devoted, data driven policy geek who is incapable of extremist thought, much less extremist action.

Basically, Powell is as close to a human central banking computer as can exist. He's a Vulcan. He's basically commander data of Star Trek.

He is an emotionless creature of logic, which many people struggle to understand. And thus, fear him.

But I can tell you, I trust Powell not to be perfect. Of course, Lord knows he’s not.

And no one at the Fed is. They are famous for policy blunders.

But I am certain that this disciple of Volcker is a man of integrity who takes his role as our public servant and guardian of financial stability very seriously.

He and the rest of the Fed's monetary technocrats, most of whom are just as Vulcan and computer-like in their personalities, are far preferable to the alternative.

The alternative would be to have Congress actively voting on whether or not to increase or decrease the money supply as well as increase or decrease interest rates.

I can guarantee you two things.

First, if Congress was in charge of interest rates, that would be a road to ruin, madness and despair.

And second Fortress Portfolio members do not have to worry about the Fed.

Look, even if you disagree with me about Powell and the Fed, which is perfectly fine (it is your birthright as an American), know that Fortress was designed to survive and thrive under all economic and monetary circumstances.

We own companies that have consistently paid dividends for as long as 166 years (in the case of Toronto-Dominion (TD)).

We own companies that have survived two world wars, a global pandemic that killed 5% of humanity, and inflation as high as 22%.

Our companies have survived 20% interest rates and as many as three dozen recessions, depressions, and bear markets.

Barring a nuclear war with Russia (which government estimates at a 2.5% probability), Fortress will not fail.

And if we do get a nuclear war with Russia… Well, then the world is over.

The living envy the dead, and the best portfolio strategy will have turned out to be investing in Robert Kiyosaki’s doomsday bunker.

Thank you for joining us this week.

Please send us your questions and feedback so I can respond to them in these videos and other issues.

Just remember, I legally can't provide personalized investment advice.

I hope you join us in the future weeks as we help you to demystify what's going on with the economy, interest rates, and the stock market… And why as a Fortress Portfolio member, you don't have to worry about any of this.

Until then, this is Adam Galas, wishing you and your family safe investing, and a healthy and joyous 4th of July weekend!