In two of my previous articles this week, I stated how my research suggests the Fed's interest rate cut this past Tuesday will likely do little to stimulate economic growth and will serve only to increase inflationary pressures.
Although I understand the Fed's concern about the crumbling housing market and ongoing credit crunch, the Fed can't force homebuilders to construct new homes nor can if force debt-strapped consumers to increase their spending at the local mall.
Well, guess what? Many investors are apparently also recognizing the huge inflation implications of Tuesday's rate cut, as gold prices rose this morning to their highest level since 1980 and the U.S. dollar fell to another all-time low. (See the charts below).
If you're old enough to remember the early 1980s, I'm sure you remember how stock prices fell dramatically between November 1980 and August 1982 (with the S&P 500 declining 27 percent) and how yields on money market securities rose to over 17 percent.
Although I'm not suggesting that interest rates will rise to the levels they experienced in the early 1980's, you should expect long-term interest rates to rise significantly during the coming year if the Fed continues to cut short-term interest rates.
However, both short-term and long-term rates will likely trend lower before they begin rising, as investors seek "safe-haven" investments — as investors shun high-risk debt securities and flee to "safe" U.S. government securities.
Meanwhile, oil prices rose to another all-time high today, with crude oil futures for October delivery closing at $84 on the NYMEX in response to the falling dollar and last week's decline in U.S. oil inventories. With oil supplies currently at an eight-month low and demand continuing to rise, there's good chance oil prices will continue to rise over the near term. And, with oil priced in dollars, Saudi Arabia decided today to de-peg its currency to the dollar. Four other Middle East countries had already cut their currencies link to the dollar earlier this year.
In the event other countries around the world decide to de-peg their currencies to the dollar, the foreign demand for U.S. Treasury Notes and Bonds could fall precipitously over the coming months. This would be a very important development because the U.S. depends heavily on foreign investments in Treasury securities to support U.S. deficit spending. Oh, by the way, foreigners sold more Treasury securities than they purchased during July, on net, for the first time in more than a year.
So, as I've stated on several occasions in recent articles, you probably shouldn't get too excited about this week's interest rate cut. Rather, you should be taking steps to protect your portfolio against rising inflationary pressures and the possibility for declining stock prices over the coming months.
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