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Interest rates & inflation arbitrage

Where are U.S. interest rates headed? This seems to be the question that's been on everyone's mind in recent days.

Actually, it's beginning to seem like a Fed rate cut is a foregone conclusion (at least in the consensus view), and that the only real question remaining is the extent of the expected rate cuts. Will it be 25 basis points or 50?

There was an interesting discussion of interest rates and inflation in the first hour segment of the Financial Sense Newshour broadcast (September 8, 2007).

Host Jim Puplava spoke with guests Tim Wood and Paul Nolte about the likely direction of interest rates, and the economic picture going forward. There were some interesting comments made about the political outcomes of a possible/likely recession, as well as some discussion of the Fed's ability to revitalize the economy via a helicopter-liquidity drop.

Who would still want to borrow money in the next easy money cycle? Jim Puplava had an interesting response to this question voiced by Tim Wood. He noted that interest rates were still well below the double-digit rate of money supply growth, thereby allowing a possibly stimulative inflation arbitrage, with hedge funds and speculators taking advantage of this spread.

Also, Paul Nolte notes that a Fed interest rate cut is historically likely, and he expects 25 basis point cuts at each of the next 3-4 Fed meetings should economic data continue on its present path. His best guess has the Fed continuing to cut rates until the fed funds rate roughly equals core inflation, at a level of zero real interest rates, a point at which the Fed usually stops.

How are the precious metals reacting to this scenario? See, "Gold Gains on Outlook for U.S. Interest Rates, Silver Declines", for more.

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