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(Kitco News) - The damage to the U.S. economy from the Fed’s interest rate hikes is only just beginning, according to Danielle DiMartino Booth, CEO and Chief Strategist at QI Research.
DiMartino Booth joined Kitco News’ Lead Anchor and Editor-in-Chief Michelle Makori to discuss the latest signals that Federal Reserve chair Jerome Powell sent at the July meeting, and the fallout still to come from the central bank’s policies.
She said Powell has clearly communicated the Fed’s plans to continue reducing the size of their balance sheet, and that the end of the tightening cycle is on the horizon.
“I certainly wouldn't think that in 2024, we would see a continuation of rate increases,” she said. “But I think when he mentions inflation not coming to target for a very long period of time, what he's saying is this is how ‘higher for longer’ is going to manifest. We're going to keep rates at a very high level for longer than markets anticipate, or certainly are used to, in order to get that inflation down to target, all the while shrinking the balance sheet, continuing to deplete liquidity from the system.”
She expects this course of action by the Fed will create new casualties as the effects of higher rates work their way through the system.
“I don't think that we have seen the full brunt, the full outcome, the full damage that rate hikes past are going to take on the economy,” DiMartino Booth said. “The New York Federal Reserve put out a survey just a few days ago that indicated that lenders that extend credit for mortgages and auto loans and credit cards, that they foresee going out into the future, the highest rejection rates for U.S. households in the history of them doing business.”
More casualties to come
DiMartino Booth said that the Fed is signaling that it’s aware of the toll that prolonged high rates will take on the economy, and that it sees these outcomes as a necessary evil.
“I think that if Jay Powell is trying to shrink the size of the Fed's balance sheet and change the narrative away from zero-interest-rate policy, take quantitative easing away from the Federal Reserve as a future tool, he's going to have to maintain a higher-for-longer policy regardless of the damage that it might or might not do to the U. S. economy,” she said. “I think he's trying to say that there will be casualties in order for the Fed to extricate itself from failed monetary policy.”
DiMartino Booth said that even though some recent employment indicators have come in better-than-expected, the U.S. labor market is weak and extremely fragile. “We still have massive levels of federal fiscal stimulus that is holding up this economy,” she said. “And yet at the same time, 93% of the U.S. population is living in a state with rising continuing jobless claims. Last September, that percentage was zero. So we definitely have a very slow-rolling recession that is moving in.”
Declines in commercial and industrial loans and forced bank mergers like the one between Banc of California and PacWest earlier this week are also signs of “damage being done by Federal Reserve policy,” she said.
“After First Republic, the assumption in the investing community was that PacWest would be the next bank to go,” she said. “So what we're seeing is something that is slow-moving in nature, but if you're having forced marriages, and JP Morgan announcing that it's going to be buying $2 billion of mortgages from this brokered deal, we're clearly still in a situation with tightening lending standards.”
Commercial real estate is next
She added that commercial real estate will be “the next shoe to fall” for American banks. “What we're seeing right now is a lot of extending and pretending,” she said. “If it's trash, it's being traded. If it's a trophy, it's being traded. But everything in the middle is right now frozen. And you're hearing one bank after another say, ‘We're having to pay up to keep our deposits,’ and that means continued compression with net interest margins.”
“I doubt that the PacWest forced merger with Banc of California is going to be the last one that we see, but PacWest was indeed that next domino that was going to fall, and it has fallen.”
Bold in gold, zero exposure to U.S. equities
DiMartino Booth has already advised investors to be bold with their gold allocations during this rate cycle, and she said she’s putting her money where her mouth is today. “I do have more than I would normally have in gold,” she said. “By the same token, I have more than I would normally have in cash, because it's paying me 6%.”
And despite the strong performance of U.S. stocks, with the S&P 500 up over 19% in 2023, DiMartino Booth sees major downside risks for equities, and she wants no part of them. “Am I in the stock market? If that's your question right now, I'm not in the stock market,” she said. “No exposure to equity markets at the moment. Zero.”
She said that her clients continue to take positions in equity markets. “There are plenty of places where you can hide in the stock market right now,” she said. “But my feeling on aggregate valuations is that they simply are not in a place where a ‘Black Swan’ event couldn't take them down, very much precipitously.”
To hear the other key asset DiMartino Booth favors in the current economic environment, watch the video above.
