The Fed is driving us headlong into a recession even with the Dow breaking new highs.

The Fed has to aggressively lower interest rates.

They’ve raised short-term interest rates in an effort to raise long-term rates. What has occurred, though, is an inverted yield curve and it will remain inverted as long as the Fed either does nothing or goes back to raising interest rates which will exacerbate the situation.

Foreign investment, specifically Japan, is able to borrow at extremely low interest rates and are investing in US Government securities, i.e. the U.S. 30-year bond, thus driving long-term interest rates lower. Until the Japanese government raises their interest rates, our long bond will remain low.

This is in a locked position; our government has raised short-term interest rates, the Japanese are keeping long-term interest rates low and this is going to put the inverted yield curve at a stalemate until one of those two positions changes.

The Fed, probably because of a new Chairman, stopped raising interest rates where, normally under Alan Greenspan’s watch, it most likely would have kept raising them. Nonetheless, this situation will continue until the Fed lowers interest rates. If things continue in this manner, we’re almost guaranteed a recession.

Q. Japanese interest rates have been low for a long time. Why weren’t Japanese investors buying 30-year bonds for the last 10 years?

A. Interest rates have been low in Japan for an extremely long time but we gave them a booming stock market to invest in rather than our bonds. Remember, when the market was really moving in ‘98 to 2000 everybody considered that a guaranteed return like a bond.

Q. So if that’s the case then they should be investing in the stock market now with the Dow poised to make record highs. Why are they still buying 30 years instead of investing in our stock market?

A. First of all because of human psychology; the market crash is still fresh in their minds. The other more technical reason is because in the late nineties and in early 2000 there were a lot more active traders. Volume in the market was coming from a large number of individuals. Since the crash, it’s now gone to computerized volume trading. One of the biggest complaints from floor brokers right now is the actual lack of volume, meaning active in and out trading versus this computerized directional volume. Even though we see volume to be the same numerically as it was in 2000 it was a different type of buyer: more active. Therefore it’s tougher to get position trading so the Japanese are going into the bond market and getting their guaranteed long-term return.

Q. There’s a lot of argument for the economy being in good shape right now. We’re seeing the stock market getting ready to potentially break new highs, unleaded has dropped almost $10 a barrel and consumer confidence is up. How can you say we’re heading toward a recession?

A. Because the stock market is being driven by the program trading of only a handful of people and in addition to that we’re not seeing overall support of the market. The S&P 500 and the Russell 2000 are still well below their 2000 highs. In regards to unleaded, it always goes up during the summer driving months. It went up so high this time because the over-aggressiveness of traders through their lack of having anything else to invest in and therefore we saw a more dramatic drop than usual at the end of the summer in the price of unleaded. As far as consumer confidence is concerned, they’re happy because fuel prices are lower but, as an economist, that would only be an advantage to the economy if that money were to be saved and invested in the short-term rates. Our society dictates that they’re not willing to save, so that means that this expendable income will go toward chasing goods and too much money chasing too few goods is a definition of inflation.

If we’re going to get out of this, the Fed needs to cut rates in order to return a normal yield curve, because the buying pressure is just too high on the 30-year.