Financial markets experienced another volatile week due to the Fed and inflation. There are fears that the Fed’s aggressive tightening monetary policy will hurt economic growth and corporate profitability. However, Jerome Powell tried to reassure investors by excluding the possibility of a 75-basis point increase at the next two meetings.
Investors are rightfully frightened by the possibility of losing growth they once considered untouchable. Central banks are gradually moving into the anti-inflation camp. The optimists are optimistic that these efforts will yield positive results without harming economic activity. Most investors are not starting to face the fear of a hard landing. Market pessimists speak of stagflation, citing charts from previous oil shocks.
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Will the Fed give us a soft landing or recession? This is the question on everyone’s mind. Spoiler alert, the Fed has only a 23% of soft landings in the last 60 years. Economists are expecting a retraction of GDP, how much is still unknown. The best examples of “soft landings” are 1965, 1984, and 1994, BUT they have little in common with our current situation.
Jerome Powell, Fed Chairman, warned us in his two last speeches about the pain that is currently underway. After several rate increases, the Fed hopes for a soft landing that will limit growth’s damage. However, stagflation may occur if the landing feels more like a BIG BOOM (a much rougher landing).
Investors are particularly concerned about this scenario. Investors are apprehensive about this scenario. Isn’t it a bit late for the Fed to raise rates? We will only know the outcome of this experiment regarding raising rates. Last week demonstrated that the market doesn’t believe in a soft landing nor is it more interested in a painful one.
The Fed’s stated goal is to reduce enough demand to manage inflation, and however, they should not cause a recession by destroying too much demand. As previously reported, the Fed has been causing recession 77% of the time in the past 60 years.
The Fed has achieved “soft landings” of approximately 23%, and this is a low baseline probability, and money managers are still skeptical that the Fed will pull off a soft landing. Last week a local realtor in a hot housing market had 0 people show up for an open house. If the real estate market is anyway associated to the market, we are in for a world of pain.
The Fed is working to reduce the number of dollars in the economy that is causing inflation today. This comes after setting printing dollars for the M1 money supply during Covid.
The majority of the rest is driven by supply chain disruptions that continue to plague global markets. According to IMF research, an aging population is also inflationary. This argument supports sustained structural inflation even if monetary and demand imbalances are sorted out.
There are many reasons to expect that the supply situation will worsen next year and boost inflation. The sad reality is that the real inflation number is much much higher.
Decentralized finance (DeFi) firm Truflation is based on the same calculation method as the CPI but is different in that it uses real “price data” versus the government’s survey data. It uses current real-market prices data from sources such as Zillow, Penn State, and Nielsen to measure and reports inflation changes each day.
Here are four big ones:
First, if US intelligence proves accurate (and I believe they are), then the Russians are preparing for a long-running conflict in Ukraine. This will continue to disrupt global food prices. Not only because of continued sanctions against Russia but also because of wheat exports, which in turn disrupt Russian fertilizer and oil exports. Russia’s sanctions have pushed countries to adopt protectionist policies. Numerous countries have reported that they are reducing or stopping exports of fertilizer and food.
The Biden administration has not yet reduced sanctions or implemented carve-outs for key Russian exports. This is likely to continue as Russia’s campaign in Ukraine continues. I also expect protectionism to spread to other countries as the food crisis worsens. This will increase global food insecurity by rising fuel and fertilizer prices. Agriculturists in Ukraine estimate that it could take three years to recover previous wheat production.
Second, China’s continued lockdowns have hampered much of the economy and caused container ships to pile up at major ports. As the government attempts to stop the spread of COVID, further restrictions will be placed on Shanghai, China’s biggest city and port. Already, the United States is feeling the effects of lockdowns, and supply shortages in China will only worsen.
Third, the oil and gas prices will continue to be high, leading to downstream price increases. Biden’s administration cites a lack of interest in a decision to cancel oil leases from Alaska and ongoing legal challenges in canceling oil leases from the Gulf of Mexico. According to the Energy Information Administration, refining capacity will increase slightly and reach its maximum this summer as more people travel during the summer months. Prices will continue to rise as long as infrastructure development and political policies to limit America’s oil and gas production.
Fourth, the Producer Price Index continues to rise. According to the Bureau of Labor Statistics, production input costs increased by 11% and 0.5% over the past year. The consumer will see an increase in production costs, resulting in higher consumer prices.
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