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  • Writer's pictureIshfaaq Peerally

The Problem with Fed Cutting Interest Rates

Unfortunately, the markets $SPX500 are up today after the Fed says that they will inject $1.5 trillion. Why unfortunately? Because we won't be able to buy anything today. Yesterday, I took the opportunity to add some Skyworks Solutions. This is a stock that is really getting cheap and I'll be adding more positions if the price falls further. Another stock which I'll be buying is GameStop as we can expect something big with this stock in the coming months.

The Problem with Fed Cutting Interest Rates

The Fed lowered interest rates last week in order to prevent the markets from crashing further (it didn't work) and now they are going to inject $1.5 Trillion in the system. Why low interest rates are bad?

The Federal Fund Rate, commonly known as interest rates, are overnight lending rates between banks. When a bank run out of money overnight, they can obtain a loan from another bank, which they then repay the following day. This is how money is created in the system. If interest rates are low, the banks will have to lower other rates, for example, mortgage rates. All other interest rates, bond yields, discount rates on stocks are determined by this interest rate.

Interest rates also determine inflation and unemployment. Low interest rates mean high inflation and low unemployment rate. Right now, however, we are in a goldilocks economy where all three numbers are low. This is unsustainable for the long-term. Inflation is low because mainly of technological advances. Companies such as Amazon $AMZN are keeping inflation low. The recent fall in oil $OIL prices will also keep inflation rates low.

Usually, the Fed will lower interest rates by 500 basis points in a recession to stimulate the economy. The problem we face right now, is that interest rates are so low that they cannot go down further. Real rates are already negative and negative rates are bad for banks and other financial institutions. The Fed will be forced to print money through Quantitative Easing.

The Bank of Japan is already buying ETFs holding stocks. The Eurozone Central Bank is buying corporate bonds. All this printed money will go to rich people, people who own financial assets. And this creates a wealth gap which leads to populism. In the future, taxes will be raised. That's the only way populist politicians can keep their promises. Higher corporate taxes is bad for innovation.

As a good investor, what you can do is diversify your portfolio globally. In China, for example, interest rates are not that low and in case of a recession, they can lower it further without putting too much pressure on the banks. The other thing you can do is buy commodities or commodity stocks. If inflation rises, gold $GOLD prices will rise. So will oil, which is denominated in US Dollars. Now is the time to invest in commodities.

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