In physics there is a concept called “terminal velocity”. We could get academic on the subject, but for today let’s say we don’t.

Terminal velocity, for our purposes, roughly means the max speed objects reach when falling in gravity. The exact number is something like 128 mph. Then they don’t fall any faster. Even weight and mass don’t matter.

If you want to get more scientific on the idea, here’s a chart that uses a tennis ball:

The geeks who are constantly trying to disavow human action and turn economics into a science have glommed onto the term “the terminal rate,” taking the language from more physical sciences.

Yeah, we know, it doesn’t fit exactly.

In an attempt to humor those who practice the dismal science, we asked Jim Rickards about it in this week’s Wiggin Session:

The terminal rate is a rate set by the Fed that’s high enough to bring inflation down without further rate hikes. We get to a level high enough that inflation will come down on its own just by waiting without raising the rate again.

The conundrum the Fed faces right now is that they have been raising rates and inflation has been coming down. Those two things are true. But is inflation coming down because they’re raising rates? In which case maybe you want to keep raising them…

Or are they already at said terminal rate? In which case it’s coming down on its own. Now the danger is… they may go too far. That’s the debate with Wall Street.

The question for the Fed is how much pressure they ought to put on interest rates before they tank the economy and thereby kill stocks.

Seems like a fairly basic idea, but we all need to spill a lot of ink explaining it, don’t we?

For Wall Street, who is keen on betting, the game is trying to figure out just how long investors can hold out before the earth shifts beneath their feet. Rickards continues:

Who’s right? Well, there’s an old saying on Wall Street: Don’t fight the Fed. I don’t think of it as who’s right or wrong. You could have an opinion. The way I think of it is, I just want to know what you’re going to do because if I know what you’re going to do I can trade accordingly.

If they do what they say they’re going to do, you can prepare for it. And what they’re going to do is they’re going to keep raising rates even if they’re at the “terminal rate” already. By the time inflation comes down enough to say, yeah, okay, we’re at the terminal rate, nice job, it’ll be too late. They will have gone too far because the Fed’s always the last to know.

The Fed is always the last to know because, by their own admission, they are data-driven. It takes a while to compile the data. Jerome Powell’s testimony before Congress yesterday only verified their numero-centric decision making process.

Regardless, we can count among the known knowns more rate hikes are on the way. It’s only a question of how much at this point, right? Given job opening data released yesterday, also, the next hike on March 21 is looking more and more like 50 basis points.

Stocks are not going to do well with extended, projected and prolonged hikes. Following Powell’s comments yesterday, the Dow languished in solitude most of the day. Today, it shed about 800 points.

Like Rickards, the masses are waiting to do what everyone else is not doing. And in doing so, they are doing exactly what everyone else is doing.

“That’s a central banker’s worst nightmare,” Rickards concludes. “People begin to say, ‘Why should I buy anything? I’ll just sit on my money and wait for the price to come down, maybe buy six months from now or maybe wait a year.’ Then unemployment goes up, businesses shut down, stock markets crash, etc.”

Here’s an interesting investment “parlay” in the meantime.

Move money into a 1-year treasury. Granted 1-year notes are not that common but today they are paying 5.25 percent. The two year notes (often those cited on the news) are only paying 4.1… the ten years are paying 3.9.

These numbers mean bond traders are still expecting the Fed to pivot within the year.

We personally think they won’t… but that’s why we bought the one year.

If the S&P 500 declines by 5%, you get a 10% gain. We’re forecasting an even bigger drop in the S&P. You can do your own math, and short-term treasuries are paying you to take the risk.

Normally, when writers talk about an “inverted yield curve” they’re assuming it’s going to signal a recession. History shows it will, but whatever. So, the year of the t-bill? You can take the spread in the meantime.

So it goes,

Addison Wiggin
Founder, The Wiggin Sessions

P.S. If the S&P drops 26%, like Morgan Stanley bears noted last week, then your gain is essentially 31%. Granted, it’s very crude logic, it is worth considering. Rickards said in our interview he thinks Mike Wilsons’ forecast for a 26% decline might even be conservative.