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089. The Federal Interest Rate as a Predictor?

A as the Federal Interest Rate decline, a retired investor will be looking for clues about a pending recessions that will collapse the current stock market prices. 

The cyclical behavior or the Effective Federal Funds has shown a remarkable pattern showing a recession indicated in vertical gray strips. []

The recessions have shown a remarkable repeat patterns. There were ten years between recessions from 1980 through 1990. It took ten years between recessions from 1990 thorough 2000. The next interval between recessions was only seven years (between 2002 and 2009). The current interval between the "bubble" cycle is eight years old. There is no question that current economic conditions indicate that there will be a forthcoming recession. The question now is only when that will happen.
We have picked the federal funds rate because it is the central interest rate in the U.S. financial market. It influences other interest rates such as the prime rate, which is the rate banks charge their customers with higher credit ratings. Additionally, the federal funds rate indirectly influences longer- term interest rates such as mortgages, loans, and savings, all of which are very important to consumer wealth and confidence. 
The effective federal funds interest rate is determined through open market operations or by buying and selling of government bonds (government debt). The stated objective of the Federal Reserve is to keep the inflation under control by decreasing the liquidity by selling government bonds, thereby raising the federal funds rate because banks have less liquidity to trade with other banks. Similarly, the Federal Reserve can increase liquidity by buying government bonds, decreasing the federal funds rate because banks have excess liquidity for trade. Whether the Federal Reserve wants to buy or sell bonds depends on the state of the economy. If the Federal Reserve believes the economy is growing too fast and inflation pressures are it will dictate a higher federal funds rate target to temper economic activity. [] 

The federal funds rate is the interest rate at which depository institutions trade federal funds with each other overnight. When a depository institution has surplus balances in its reserve account, it lends to other banks in need of larger balances. The rate that the borrowing institution pays to the lending institution is determined between the two banks; the weighted average rate for all of these types of negotiations is called the effective federal funds rate.

I label the cyclical behavior shown here as a "politically motivated action" by the Federal Reserve Bank (which is not an agency of the Federal Government). For the past 40 years the increasing liquidity of the US (in the face of rapidly rising debt) was kept up through large-scale purchases of Treasury bonds by foreigners (mostly China, Japan and EU) who relied on the strength of the US dollar to keep their Treasury holdings as a good reserve investment. 

With a continuing rise in US trade deficits (accumulating liabilities of over a $ trillions) as well with a continued rise in the budget deficits of the US and State governments (plus rising credit card and student loan debt) the Federal Reserve Bank will have no choice except to raise the cost of interest to be paid on a rising outstanding dollar debt (while the dollar simultaneously depreciates). 

The three prior recessionary cycles (1990, 2000, 2010) have been always preceded by a short-term rise in Federal Interest Rates but were then followed by a plunge to lower levels. The problem with the forthcoming recession is that the Federal Interest Rates have now leveled off to near zero. That will prevent the US to apply "monetary easing" (e.g. pumping more debt) into the global financial system that is now seeking ways how to depart from reliance on global dollar currency. 

The US dollar, originally backed by gold until 1971 has served the global economy well since Bretton Woods [1944]. Unfortunately, it is now starting to collapse as suggested by the forthcoming Federal Interest Rate cycle that now appears to be approaching a dead-end of US global dominance.

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