Last week saw a rebound in equity markets and investors returning to calm after weeks of volatility. Jerome Powell, the Fed Chairman, is taking things seriously. He announced a quicker than expected rate increase to counter inflation in half the points instead of quarters. This will result in a total increase up to 2.5 points at the end of this year.
In the face of rising inflation, the stock market seems pretty accommodating. The apocalypse has been postponed as a result. Even the IMF believes that the global economy will be able to escape recession in the coming year. Although the clouds are clearing, good weather shouldn’t be taken as a given. Many people would caution and say this is the calm BEFORE the Storm. (I explain later)
After two weeks of solid gains, the European markets finally stopped in this weekly sequence based on the hope of progress in the talks with Russia and Ukraine. Traders are still trying to process the Federal Reserve’s first tightening of monetary policy, ongoing clashes, sanctions against Russia, and the recent surge in oil prices. The Federal Reserve’s first monetary tightening has influenced more defensive sectors. However, volatility has declined significantly over the past month.
The Biden administration announced plans for countries to help Russia avoid western sanctions. Jake Sullivan, National Security Advisor, stated Wednesday that the US had prepared a unified response to other G7 countries to ensure no significant economy can weaken or undermine sanctions against Russia. He said that the US had sent that message to China and that it expected European Union countries would follow suit soon.
According to reports, the plan would prevent Russia from accessing critical goods like commercial electronics, computers, and aircraft parts. Sullivan said that the United States would not accept “systematic attempts” to reorient financial payments away from the dollar.
I won’t bore you with history, but the short and skinny is that Oil is quoted in US dollars per agreement in 1973 between the US and Saudi Arabia. This created the “Petro Dollar” and set up the US Dollar as the default world currency.
The Chinese and Russian appear to be slowly trying to get a percentage of oil deals changed over the Chinese Yuan. This would cause a weakness in the US Dollar. Currently, the US Dollar is trading at record highs due to the war and counties/investors seeking safety.
Although, I think this is a very long-term strategy for China. They have not been able to gain a strong foothold, but it is something to watch.
The Fed & Interest Rates
Last week, Powell gave a second speech Monday and made it clear to financial markets that the Fed would likely accelerate its rate increases to reduce inflation. This communication was probably carefully planned: flexibility first, firmness last. The investor side of the story was a success, as it drove stocks higher.
We were a little surprised last week with the strength of the PMI activity. These surveys were conducted among large purchasing managers in the middle of the conflict in Ukraine and were conducted from March 11 to April 11. Fears about the war were outweighed by lifting restrictions related to pandemics.
We see the continuation of the previous week’s market concerns this week, This includes:
By raising interest rates, the Federal Reserve could cause a recession. Recall that 10 of the 13 most recent rate hike cycles ended in recession. However, there have been “soft landings” circa 1996, 1984, and 1995. This week, Jay Powell, Fed Chairman, stated that he believes the Fed can achieve a soft landing. Powell is, unfortunately, being sabotaged by history and current circumstances. For example, take the yield curve between 10-year Treasuries and 2-year Treasuries. This yield curve has historically been a strong indicator of recession, and it is very close to indicating another recession within the next 12-18 months.
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This week, Jim Bullard, President of the St. Louis Fed Bank, stated that all signs point to higher inflation in spring. Although he didn’t give a timeframe, let’s examine the facts. First, the Fed increased its Federal Funds Target rate by 0.25 percent, and the Federal Funds Effective rate is now only 0.333%.
There are only six weeks left before the Fed holds its next meeting and increases its rate. To reduce inflation, tightening monetary policies will take time. We will see an increase in oil and gas prices, food and fertilizer shortages, and a tightening of monetary policy. There is much talk of future “aggressive” action, but the Fed is not moving fast enough. The likelihood is that inflation will rise.
Increased Prices “Normalization”
The US Department of Agriculture reported that fertilizer prices increased 17% last year and will increase by another 12% in 2019. There are a few options for US farmers to take. First, a decrease in fertilizer will result in lower yields, and some farmers will reduce their planting, which will result in lower yields. Third, some farmers may switch from fertilizer-intensive crops like wheat and corn to lower-requirements crops, resulting in lower overall yields. There is a risk that similar effects will be seen in industrial food production to what we saw in the global supply chains over the past year, and this will increase food prices.
Blackrock’s Larry Fink believes we are witnessing the end of three decades of globalization due to the Russia-Ukraine conflict and the pandemic. As the West waged an “economic war” against Russia and threatened sanctions against foreign companies that help Russia, countries are reminded of how “access to [US] capital market is a privilege and not a right.”
This will prompt governments and companies worldwide to reevaluate their dependence and reassess their manufacturing footprints, resulting in higher costs and near-shoring. Fink rights: “[A] large scale reorientation [of supply chains] will inherently be inflationary.” Adopting digital currencies, such as the Fed’s forthcoming Central Bank Digital Currency (CBDC), and a “global digital payments system” like the Fed’s upcoming Central Bank Digital Currency will lower international business costs.
Debt & More Debt
Recently, the national debt surpassed $30T, which could lead to the Fed taking a more aggressive stance. Nonfinancial corporate credit reached $11.6T, while consumer credit outstanding was $4.3T.
According to the Fed’s latest semi-annual report on Monetary Policy, corporate debt is still within the historical range. In 2018, the Fed’s semi-annual report on monetary policy stated that corporate debt was a “highly elevated” risk. Corporate debt increased during the COVID pandemic because of disruptions and the low cost to borrow money. Corporate bonds could be at risk as tighter monetary conditions mean that borrowing costs and debt servicing will rise, leading to increased interest rates.
Putting it All Together For the Perfect Storm
As mentioned earlier, there are many elements forming to create a recession/depression of historic proportions in the markets. No one knows the future. It is likely we will see some kind of BEAR market (likely we are in it now).
The Fed sees rising inflation as a runaway train. Many people have speculated that it is impossible at this time to stop. While others have said that inflation is temporary and 100% controllable.
Personally, I think the problem is that we fail to address the primary cause of inflation: government spending. Our fiat currency can’t handle the debt load and Congress is likely to make it worse by spending more. We are seeing proposals in Congress to give money to people for gas and increased groceries. Although these measures may seem to be well-intentioned, these are the same things that got us rising inflation in the first place.
The worst scenario is:
- The Fed raises rates too fast putting the US into recession.
- A recession causes cash flow problems for overleveraged companies.
- Companies dump assets for cash, which causes devaluation.
- Congress passes more spending bills.
- Debt spirals out of control on both US Gov’t and Corporate Sides.
- Resulting in a massive economic collapse.
Bonds continue to get KILLED and the STRONG BEAR trend likely to continue for some time. The Fed’s hawkish attitude helped drive the yield on US 10-year debt back up to 2.46 percent. The Bund in Germany rose to 0.56%, while the OAT flirted with 1% in France.
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.
We are seeing renewed energy on the crypto-currency front this week. Bitcoin recovered almost 10% and returned to $47,000 and the trend seems very BULLISH! The Nasdaq is still tied to crypto-currency. Although bitcoin has been closely linked to the US technology index for many weeks, it shows that it is not an unregulated safe haven, despite having much greater volatility.
This week, Jamie Dimon, CEO of JPMorgan Chase, called for a Marshall Plan and significant investments in energy security for Europe and the US. This will likely lead to higher oil prices in the long term due to lower US oil production and a greater focus on green energy development and geopolitical from Russia and to the Middle East.
Due to the Black Sea supply issues, oil prices have retraced their upward trend. However, even though the European Union is trying to reduce its dependence on Russian hydrocarbons, it does not intend to impose a total embargo. This has helped curb this buying fever at week’s end as Russia supplies 30% of European oil requirements.
The US oil-and-gas company output reached its highest level in six decades. The Federal Reserve of Dallas surveyed major industries and found that 15% of large companies plan to increase their growth by 30% in the coming year. Respondents forecasted that US crude oil could reach pre-invasion levels by this year. These long-term predictions contrast with short-term forecasts by top oil traders who warned that prices could rise to $200 per barrel.
The upward trend in metal prices has also been resumed. The Covid-19 pandemic’s resurgence continues to disrupt China’s supply, and this constraint exacerbates tensions in supply chains already stretched by the Russia-Ukraine conflict. This supply shock drives prices higher, associated with less short-term availability. Copper trades at USD 10,420, aluminum trades at USD 3670, and Zinc trades at USD 4140. Nickel is currently trading at USD 37 200, reaching its daily trading limit of +/- 15%.