The world’s largest stock markets saw a recovery this week. The Fed increased rates by 0.25 points on Wednesday, as was expected. However, the markets are adjusting to the conflict in Ukraine. On the other hand, inflation is taking root in a very permanent manner. Inflation could rise to new heights due to supply chain bottlenecks, strong post-pandemic household demands, and possibly embargoes against Russia.
China’s government is seeking to take measures to improve the economy and stabilize financial markets, and they also want to develop policies that protect property rights. Investors are more cautious now that they have heard this news, which has rekindled their enthusiasm. However, investors should be aware that the optimism is still fragile and could be shaken by bad news.
Last Wednesday, the U.S. central banking launched a new monetary cycle with its first-rate increase since 2018. As expected, the hike was for the minimum union rate, which was a quarter-point. It is now 0.25 to 0.50, not 0.25 to 0.25. The theory is that raising rates decreases the money supply and calms inflation. The transmission belt is not instantaneous or automatic, however. To stop the price overheating, the Fed will keep increasing rates throughout the year. The Fed wants to maintain the economic momentum but not stop it. Given the current external shocks and the central bank’s late awakening, this is a delicate balance.
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The US economy is under a very dark cloud this year. Consumer sentiment is declining, inflation numbers are grim, and falling consumer sentiment. Last week’s Federal Open Market Committee press conference saw Jay Powell, chairman of the Federal Reserve, optimistic that the Fed could bring down inflation. It is unlikely that this will be the case. The February Consumer Price Index (CPI), which measured inflation at 7.9% annually, came in at 7.9%.
This is an increase from 7.5% in January and 7% in December 2021. CPI is expected to rise in March, as the Producers Price Index (PPI) broke at 10%. Real inflation is likely to be much higher than 7.9%, consistent with the assertions made. If calculated in the same manner as CPI in the 70s, it would probably be somewhere around 16%.
The Fed is unlikely to be able to control inflation with interest increases anytime soon. There are strong reasons to believe this. The Fed has needed to raise rates as high as the inflation rate to reverse the Great Inflation. This could take years to complete with CPI at 7.9%, Fed raising Federal Funds Rate by 25 basis points each quarter, and Fed raising the Federal Funds Rate by 25 basis points every quarter. Powell claimed that most of the inflation was due to logistics bottlenecks and demand. This is fair. Powell stated that he anticipated higher prices to cause a temper in demand, theoretically bringing down inflation.
We are likely to be in the same inflation cycle as the US did in the 1960s. Government spending on the Vietnam War and President Lyndon Johnson’s Great Society drove inflation up. As we see large spending bills being proposed and passed by Congress, the Johnson administration refused to reduce government spending, driving up inflation. Only one year ago, Congress passed Joe Biden’s American Rescue Plan at the cost of $1.9 trillion. This money impacts the US economy and is unlikely to be the final major spending bill under the Biden administration. Janet Yellen, Treasury Secretary, warned that the US will likely see another year of “very uncomfortably high” inflation. Jim Bullard, President of St. Louis Fed Bank, warned that inflation is not out of control.
Jeff Gundlach from DoubleLine believes that we will see 10% inflation before reaching 7.5% at the end of the year. Since 2017, Greg Jensen and Ray Dalio from Bridgewater have forecasted a new era in stagflation. There is no change. Fidelity’s Jurrientimmer expects inflation to moderate sharply to end at 3-4%. This is highly unlikely, I think. Jan Hatzius, Goldman Sachs’s chief inflation officer, leads the charge. Hatzius predicted a sharp downward trajectory for inflation last year.
There are also warnings. For example, Larry Summers, former Treasury Secretary, has warned of an inflationary scenario. Summers now says that the Fed will need to raise interest rates to 5% to combat inflation. This is almost four years away at 25 basis points per quarter, and Summers claims there is only a 25% chance of a soft landing. In other words, the Fed will raise us into recession.
Scott Minerd, Guggenheim’s economist, predicts deflation on the subject of recession. He stated earlier this year that we were headed for an Eisenhower depression when the US went through a post-war recession followed by a deflationary bust (1957-1958). Many of these months saw 0% inflation every month. According to Kyle Bass, Hayman Capital, we could see a recession when the Fed raises rates above 1.5%, which could happen as early as this year. David Rosenberg also predicts a recession this summer.
The US’s Gross Domestic Product (GD) was 5.7% last year. Already, economic growth is declining. The Atlanta Fed’s GDPNow projecting an annual rate at 1.2% for the first quarter will not be released until March 30th, and this is subject to change from week to week.
The TIPP Economic Optimism Index continues to point downward. The Empire State Manufacturing Survey is a leading indicator for GDP growth, and it is also showing a decline.
Let’s wrap it up by taking a look at logistics. The wait times at Long Beach and Los Angeles, two of America’s busiest ports, have fallen from 15-25 days last year to 2-3 days as of yesterday (bottom chart). However, there is some disruption at key Chinese ports, which is a positive sign. The Yantian port is still operational, but Shenzhen has been re-instated by the Chinese authorities. Future lockdowns may cause shipping delays and increase Far East-to-West Coast Freight-of-All-Kinds shipping costs (top left of chart).
I don’t think inflation will slow down just yet or anytime soon. CPI will likely remain high and could continue to rise, particularly with the high PPI numbers. The summer months are characterized by increased consumer demand, and we’re entering a global food crisis. Prices will not fall for at least the next year.
The good news is that markets were prepared for the Fed movement. The announcement caused some hesitation in the U.S. stock market, but it soon rose. The dollar, strangely, cannot benefit from this, and it remains within the 1.10 USD/1 EUR zone. However, the greenback continued to climb against the yen to JPY119.34. The confirmation of the news cycle in monetary tightening prompted the increase in yield on U.S. 10-year debt to around 2.155%. The Bund in Europe is at 0.35%, OAT at 0.811%, and Gilt at 1.5%.
Financial advisors and investors should take note that the US 10YR yield went over 2% which is over the average S&P 500 dividend. Bonds are getting crushed, but we think investors will start moving out of equities into higher-paying conservative investments such as CDs.
This week, the cryptocurrency market is feeling less nervous. The market leader, bitcoin, has hovered around $40,000 for many of the past days, despite a very volatile geopolitical environment. In this volatile political and economic environment, investors may not be able to purchase digital assets that are considered high-risk assets. This is a situation that will test crypto-investors nerves. They are used to high amplitudes on crypto-currency prices.
This week although oil prices lost some ground due to volatility, they have not fallen. These sessions have been turbulent, with violent daily movements up and down. Operators closely monitor the talks between the Russian and Ukrainian delegations to see if there is any sign of appeasement, which would be a signal of a decrease in prices. Prices are currently above the USD 100 threshold at the global reference Brent (USD 107) or WTI (USD104) prices. The supply remains tight. This prompts the International Energy Agency to ask OPEC countries for significant increases in production at their next monthly summit. The cartel is not influenced by this demand for production and will continue to follow its plan of gradually increasing production quotas.
This is bad news for gold buyers who can see the price of gold moving away from USD 2,000 per troy ounce despite rising inflation, uncertainty, and the war in Europe. As evidenced by changes in major stock indices worldwide, investors have shown some signs of a renewed risk appetite. This is not only at the expense of gold but also the precious metals segment as silver, palladium, and platinum all experienced a week of declines. It is time to relax in industrial metals. This is a legitimate pause after the rally achieved by the whole segment. Copper is stable at USD 10,165 while tin is climbing to USD 41,8550, and aluminum is trading at USD 3288 per tonne. The LME is having difficulty getting nickel trading back on track, and nickel prices quickly reached the LME’s maximum daily limit of +/-5%.