The markets are still awaiting news from Ukraine. However, they are also keeping an eye on monetary policies. The Fed is set to start its rate-hike cycle to combat inflation, which remains unchecked. As Wednesday’s rally shows, volatility remains high. Investors are still evaluating the long-term effects of ongoing political and economic turmoil.
“Progress” in Ukraine’s diplomatic front has rekindled financial markets’ risk appetite this week, despite the erratic and wide-ranging variations. Wall Street’s week was disappointing, and however, Europe saw a 2.5% increase in the FTSE 100. Despite persistent uncertainties over the Russo–Ukrainian conflict, and the ECB’s hawkish tone due to rising inflationary pressures, this is still a good result.
The European Central Bank meeting marked the week. The European Central Bank meeting was a highlight of the week. It presented a status quo regarding key rates and expressed concern about the increase in inflation. The institution pushed back the date for reducing its asset purchases to June but left open the possibility of a rate increase this year. This possibility was not even considered weeks ago. Another macroeconomic event was February’s inflation data from the United States, and it remained high. This will support a Fed rate increase of up to 25% this week.
Fed & Inflation
I have discussed the possibility that rate increases will not be sufficient to fight inflation. Last year, Larry Summers, former Treasury Secretary, warned that we could be facing late-60’s-style runaway inflation if the Fed cannot control rising prices. Jerome Powell, Fed chair, told Congress this week that he doesn’t know how much inflationary pressure will continue. “We will see inflation rising at least for a time, and we don’t know how much longer that trend will continue. We could also see a decline in risk-taking sentiment, leading to lower investment and people reducing their spending.
Two types of inflation are currently occurring: monetary (demand-pull) and production cost (cost-push). Monetary inflation occurs when too many dollars chase too few goods. This is partly due to the Fed’s quantitative ease and economic stimulus payments. Demand-pull inflation is also a result of supply chain bottlenecks that have led to shortages. Cost-push is a result of rising commodity prices and higher production costs. In theory, the Fed can combat monetary inflation by increasing interest rates, making borrowing more costly, and taking out excess dollars from the economy. However, it cannot counteract world events and political policy (e.g., limiting domestic oil production).
All other costs associated with commodity prices, especially oil, natural gas, and coal, will continue to rise as long as they continue to climb. The cost of crude oil has risen 465% since the 2020 lows. Natural gas prices have increased 200%, and coal prices are up 7420%. The US generates 60% of its electricity from natural gas (38%) and 21.8% coal (21.8%). This makes electricity more costly. Demand destruction is the only way to reduce higher prices. This is when people stop buying electricity because of rising prices. This may be the case in the future.
The Fed is expected to raise its first-rate by 0.5% this month. This will be followed by a series of 0.25% quarterly increases. 2% interest rates could be around two years away. This is a long time to allow inflation to persist. This may enable us to go further and predict that interest rate increases may not stop inflation. The Fed is limited in the amount they can raise rates. Recall that 10 of the 13 rate hike cycles ended in recession. The Fed could hike us into recession in the second half this year, which is likely. The Fed had historically reduced interest rates before a recession and not kept raising them. Higher interest rates can lead to higher defaults and more costly servicing of large debt amounts which is not likely what the Fed wants.
Powell stated that the Fed expected inflation to fall closer to their target rate, 2%, by the year’s end during the Senate hearing on monetary policies. This is impossible; I don’t think so. The Fed has repeatedly told us that inflation was not happening over the past year, and they also said it was temporary and they don’t know how much longer inflation will continue. They simply don’t have any credibility in predicting that inflation will fall to 2% this year or next year.
The February inflation rate was 7.9% last week. This is a significant amount of inflation to control by the end of the year, given persistent supply bottlenecks as well as high energy prices. Although we may see a decrease in CPI this year because of base effects (inflation slowing relative to high inflation a year ago).
Companies stop Russian Operations
Larger U.S. corporations have stopped or suspended operations in Russia. ExxonMobil, Boeing, Apple, and Boeing have stopped sales and investments in Russia. They also stopped parts supply to Russia’s critical industries. These moves are part of a broader Western nation initiative to limit Russia’s economic potential for invasion of Ukraine.
Chinese officials have directed the National Development and Reform Commission, China’s top economic planning agency, to encourage state-owned buyers to search the markets for commodities that could be scarce due to fighting between Russia and Ukraine. The NDRC has ordered an increase in oil, gas, and iron ore reserves. (AC: China’s actions are likely to put pressure on the world markets and increase prices for selected commodities. Analysts estimate that China already has 60-70% of the world’s grain reserves. London oil prices rose 7.7% Wednesday, wheat increased 7.6%, and aluminum rose 1.3%. Corn futures rose 2.9% to their highest level since 2012.
Increased Ag prices
Futures of Wheat, Soybeans, and Corn continue to see or exceed daily price increases. As global trade disruptions threaten commodities markets, the main driver of price rises is the war in Europe. The last 12 months have seen wheat prices rise by nearly 32%. The expected surge in corn prices will be accompanied by a 25% increase in annual growth, likely to continue into the summer. China has purchased ten cargoes of U.S. Corn, as the US Department of Agriculture will confirm later this week.
China Banks Help Russians (Worth Repeating From Last Week)
According to bank officials, the Russian branch of the Chinese State Bank in Moscow has received more requests for accounts. Reuters reported that the bank branch opened new accounts for 200-300 Russian companies in order to get around international sanctions. China is opposed to Western sanctions on Russian banks, which ban them from participating in SWIFT’s international payment system. China stated that it will continue to have normal economic and commercial relations with Russia.
It also allowed China to participate in the CIPS payment system. Many Russian businesses are reportedly in the process to switch currencies from the dollar into the yuan. However, the Russian ruble fell to a record low of 17 yuan. It lost almost 40% of its value over the past week. As the Russian-Chinese financial relations develop and banks use the new payment system, it is probable that the ruble will regain a substantial portion of its value in the coming weeks.
Russian Disconnects From Internet
Russia announced that no later than March 11, all internet traffic must use domestic “domain name systems” (DNS). It doesn’t appear to have happened, but maybe this week? This would effectively remove Russia from the global internet as only “.ru” connections would be made. This announcement comes on the heels of targeted cyber disruptions to Russian media and governmental websites attributed to the Anonymous organization.
Today’s yield on US 10-year debt increased to 2.01%. Despite inflation remaining a major concern for central banks, they see the conflict in Ukraine exacerbated by inflation. The yields on Europe’s old continent have been squeezed by the war in Europe. The 10-year German Bund is now at 0.31%, and the French OAT at 0.77%.
Bond yields have continues to trend bullish due to Fed raising rates. The Ukraine War may put pressure on the Fed not to increase rates at the same pace, but most Fed watchers remain hawkish.
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.
The cryptocurrency market has recently experienced significant volatility as the geopolitical climate remains tense. Bitcoin has seen 10% swings in one week. At the time of writing, bitcoin’s price is hovering at $38,000. Investors may hold off on buying risk assets until the international political-economic situation improves.
Monday’s vote by a European Parliamentary Committee will determine if a new regulatory framework is needed for crypto assets. This could help speed up the passage of a measure industry executives believe could effectively ban Bitcoin and Ethereum from Europe.
It was a week of excess in the metals segment, especially for nickel, which saw its price jump to USD 100,000 per tonne, its largest gain in one day. The race to fill short-term positions, after Western sanctions threatened Russia’s main producer, was a major factor in the rise of prices. Copper lost ground at $1.040. Precious metals saw gold breakthrough USD 2,000 an ounce, but it failed to maintain above that mark. The week ended with investors regaining their risk appetite, much to the detriment of the gold which trades at USD 1950 at the time.