How The Fed Manipulates The Markets

The Fed

In November of 1910 six men met at an island club off the coast of Georgia. Their goal? To meet in secrecy and write a plan to reform the United States banking system.

It wasn’t until 1930 that the six men even admitted to the existence of the meeting 20 years prior.

This meeting laid the foundation for The Federal Reserve and its system of raising and lower interest rates.

The Fed (as its know today) was founded on December 23rd, 1913 and its intention was to eliminate financial crises.

There are many who believe The Fed actually creates, increases or intensifies any typical market correction or recession into something much worse. But that is a post for another day.

We have The Fed and its not going away anytime soon.  So are they helping you? Because we know they didn’t eliminate any crises. 

Ask This One Crucial Investment Question

When The Fed increases the Federal Funds Rate, how does that affect stock, bond and commodity prices?

After all that’s the only question that matters regardless of age or risk tolerance.

Was there any consistency? Was price change arbitrary? Does the federal funds rate even matter anymore? I had to know.  

What I discovered was scary.

Let me show you.

The Image below compares the Federal Funds rate and its impact on the yield of the 10 year US Treasury (squiggly line) since 1980.

federal fund rate 10 yr

What did this chart reveal?

When The Fed raised the Federal Funds rate the yield on the 10 year US Treasury increased every time since 1980, including today. Remember when yields go up, prices go down. 

Bond Yields Up = Bond Prices Down

That means the price fell on 10yr US bond every time The Fed raised rates.

The next thing I wanted to see was what happened to the yield of the 30yr US Treasury (squiggly line) when The Fed raised the federal funds rate.

Below is that chart.

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Federal Funds Rate _ 30 year Treasury yields

What did this chart reveal?

Every time The Fed raised the federal funds rate, the yield on the US 30yr bond went up, including today. The above chart only goes to 1980 but the data I found goes back to 1954 and the data was 100% consistent!

The Fed causes bond prices to fall.

Again remember, when bond yields go up, prices go down.

What Happens To Stocks When The Fed Increases Rates?

The next thing I wanted to see is what happened to stock prices when The Fed raised rates.

The chart below shows what happens to the stock market (red line) when The Fed increases rates.

Federal Funds Rates _ Stock Prices

What did this chart reveal?

Since 1980, every time The Fed raised interest rates the stock market went higher including today.

What Happens To Commodities When The Fed Increases Rates?

Lastly I wanted to know how an increased federal funds rate would affect commodities.

Below is a chart showing the CRB Commodity Index (squiggly line) when rates increased.

Federeal Funds Rates _ commodities

What did this chart reveal?

Every time The Fed increased rates, commodity prices went higher, including today. And though it is not shown in the image above, this relationship has held true since 1971 or ever since the US Dollar was taken off the gold standard.

This then lead me to ask the following question.

What Happens To Gold When The Fed Increases Rates?

What was immediately clear: the history of gold and The Fed increasing rates has had zero correlation. This was unexpected. Since 1971 The Fed has increased rates eight times in a sustained manner. And in those eight times, gold increased in price four times and stayed flat or fell four times.

But copper increased in price seven out of eight times. That matters.

So I wanted to look at a copper/gold ratio chart to see if anything became very clear. And it did.

Below is a chart showing the Copper/Gold Ratio (squiggly line) going back to 1971.

Federal Funds Rate _ the Copper_Gold Ratio

Since 1971, when The Fed raised interest rates copper outperformed gold, including today, every time.

So what do we know?

The Fed’s actions play a major role in the price direction of stocks, bonds and commodities.

When The Fed Increases Rates:

  • Since 1954 – bond prices have fallen every time
  • Since 1972 – stock prices have increased every time
  • Since 1971 – commodity prices have increased every time
  • Since 1971 – copper prices have increased 7 out of 8 times
  • Since 1971 – gold prices have increased 4 out of 8 times

The Fed Announces Rate Increase – December 16th, 2015

What has changed to the following prices since that announcement:

  • The SP500 w/dividends = up 35%
  • The CRB (commodities) = up 12.5%
  • The 10yr US Treasury yield = up 24.6% (price down 2%)
  • The 30yr US Treasury yield = up 3% (price is down 3%)
  • Copper = up 18%
  • Gold = up 14%.

Why isn’t this information front and center at every big-box adviser in this country? Why doesn’t every adviser know this? Does your? And if not, why not?

Go back and look at the near 100% causation between Federal Fund Rates and Stock/Bond/Commodity price change. What’s scary is that most people are not taught this.

And yet the big-box adviser world continues to tell us that the investment world is too complex to understand. Too random. 

And therefore we should follow outdated ideas and concepts about how our age and self described risk tolerance is more important than what the markets are doing.

In Your Corner,

RCPeck-Dig Signature.JPG     
RC Peck, CFP


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