What Does “Don’t Fight The Fed” Mean?
In 1977, Congress gave the Fed explicit goals: stable prices, moderate long-term interest rates, and maximum employment. Interest rates and prices are considered one objective, so the goals are known as the dual mandate. The Fed’s primary tools are interest rates and money supply. Still, it can manipulate markets in other ways to achieve the same effect. Some other Fed tools are discount rates, buying treasuries, and reducing banking reserve requirements.
Since the Fed controls the boom and busts of economic cycles and long-term interest rates, there is an investment axiom, "don't fight the Fed." Essentially, the idea is to position your investment strategy and portfolio allocation in alignment with Fed policies, meaning different market conditions require different investment strategies. Some market conditions are better for higher-risk assets like stocks. In some market conditions, allocating more to security assets like precious metals is wiser. This article will discuss what not fighting the Fed looks like in different economies.
What Are the Different Market Conditions?
The Fed is trying to create an economy that is neither a boom nor a bust. Instead, they are trying to create a “Goldilocks” economy where everything is just right. Interest rates will be low when the Fed infuses the system with cash. This type of policy is called loose, dovish, or quantitative easing. It is called dovish because it is a more conservative and subdued policy, like a dove. When the Fed aggressively controls inflation, it raises interest rates. This type of policy is called aggressive, hawkish, or quantitative tightening. Hawks are aggressive birds of prey compared to doves, which symbolize peace.
Strengths and Challenges of Dovish Policies
Dovish policies are low-interest rates and money printing. Money is made readily available to stimulate the economy. Consumer spending tends to be higher in debt-based markets like mortgages, auto loans, credit cards, and starting businesses. Consumers' comfortable spending and borrowing create market stability—market stability results in higher investments and growth across different economic sectors. During dovish periods, there is usually low unemployment and high company profits. Dovish policies help the Fed meet one of its mandates. Dovish monetary policy usually leads to “bull” markets, where prices charge forward like a bull.
Inflation can result from dovish policies. The easy monetary policy causes the speed of money to accelerate too quickly, and prices climb faster than the expected 2% annually. Also, low-interest rates don't encourage saving money. Unfortunately, many people need to be more disciplined in saving money during dovish policies. There can be liquidity crises during emergencies and challenging market corrections.
Strengths and Challenges of Hawkish Policies
Hawkish policies are aggressive periods of tightening or raising interest rates. These policies are designed to slow down the speed of money and thereby quell high inflation. Hawkish policies tend to have the opposite economic effects of dovish policies. Consumer spending tends to “tighten” in debt-based markets like housing, auto loans, credit cards, and business creation. The housing market will contract because higher interest rates will make monthly payments more expensive, forcing buyers to settle for less or leave the market entirely.
Less consumer spending leads to companies lowering prices to attract consumers back into the market. Higher interest rates and lower profits are not suitable for the jobs market. Many companies slow their hiring practices and lay off many employees. Hawkish policies can lead to long-term high unemployment. Also, stock markets contract as production costs rises with more expensive business loans. Also, the bond market will lose significant value with rising rates.
The Fed can achieve its second mandate, price stability. However, price stability will destroy jobs. The advantage of raising rates is bringing inflation down. Also, savings are encouraged because investors receive a higher interest rate in the bank as their stock/bond portfolios suffer. Rising interest rates may make imports cheaper but hurt domestic producers. Depending on how the involved countries are fairing with inflation and interest rates, one currency tends to become more robust than the counterpart. The currency disparities make it cheaper to buy the import but to the detriment of the domestic producer now competing against less expensive foreign producers. The consumer may feel relief in the short term, but the producers will go out of business. The long-term economic effect will be unemployment and a contracting economy. Eventually, monetary policy will return to a dovish stance to stimulate the economy again.
Not Fighting the Fed Strategies for Dovish Policy
As the Fed loosens monetary policy, there are historically a few observable trends. Most stocks will move upward, with a few exceptions, like banks. Banks can struggle with lower interest rates. Banks make more loans but receive lower interest rates. The banks have more money deployed but not getting the same rate of return, so investors value their growth potential less. However, companies depending on debt, like automobile manufacturers, technology companies, and real estate companies, can do very well in low-interest-rate environments. The cost of goods sold decreases with lower interest rates. In general, stocks can be an excellent place during dovish periods.
Bonds can be a great place to invest as the policy changes from hawkish to dovish. When interest rates started coming down from 20% in the early 80s, bonds were the best investment to make. Like clockwork, bond prices went up every time the Fed lowered the rate or hinted at another rate decrease. Suppose one bought a bond with a 20% yield. In that case, the bond could be sold for an incredible premium a few years later when interest rates were significantly lower. When rates decline, it is usually wise to allocate a more significant portion of your portfolio to stocks and bonds.
Since most people are looking for growth during dovish periods, investors can find value in the safety sectors like precious metals and real estate. It can be incredibly wise to dollar cost average tangible assets, like precious metals, as a hedge against the next hawkish cycle. Also, alternative precious metal investments like certified and pre-33 coins could be of great value during these periods. The certified and pre-33 coins have a good track record of performance during market downturns. During the Great Depression, coins and collectibles doubled in value. They can be a good strategy during this period because they hold value exceptionally well. Also, most people start thinking about coins after feeling losses in their portfolios. Buy when assets are hated. Sell when they are loved. Buying before the crowd positions the coins for growth when reactionary investors move into assets held by proactive investors like certified and Pre-33 coins. Wise investors will make money in the stock and bond markets and transfer their gains into certified and pre-33 coins. Wise investors prepare for the next hawkish cycle when stock gains are much harder to find.
Not Fighting the Fed Strategies for Hawkish Policy
When interest rates are rising, it is time to take shelter. Stocks will contract. It is called hawkish, but it is more like a freight train. Everything is on the tracks, and the Fed will destroy everything in its path. Bonds will contract. Housing will contract. It is better to find safety assets during hawkish periods instead of looking for growth assets. Safety assets will be assets that protect purchasing power. Most investors want to stay liquid because there will be incredible bargains across multiple sectors when the hawkish policy has been around for a while. However, the problem with staying in cash is inflation. The reason interest rates are rising is that inflation is rampant. Inflation is causing cash to lose purchasing power very quickly. It becomes a better strategy to stay in highly liquid assets like bullion products or I-bills than sitting in cash. I-bills offer a decent return but are usually limited to about $10,000. Bullion products are an excellent place to store purchasing power if an investor wants to protect more than $10,000. When the market reaches attractive prices, liquidating the cash equivalents can be an excellent strategy to secure an investment bargain.
In any market, the worst thing to do is nothing. In every market, precious metals offer a protective hedge and freedom to explore riskier assets like stocks during dovish markets. Most investors will put 5-20% of their net worth into precious metals during a dovish market. That number can be as high as 40-60% during hawkish periods for some investors. Deciding on how much to put into precious metals and how to allocate money within precious metals can be daunting. The experts at the U.S. Gold Bureau are here to help. The experts at the U.S. Gold Bureau are not financial advisors, but they are experts in precious metals and which products are best in different economic environments. We are only successful when you are successful.
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