Rising Rates Are Baked In The Market’s Psyche
The latest May consumer price index was hotter than expected, with an 8.6% rise from May 2021. Core inflation, excluding food and energy, rose by a more than expected 6%. Meanwhile, the producer price index posted another double-digit increase, coming in at 10.8% in May.
Economists favor using the core number when making monetary policy decisions, but core CPI may be stale in mid-2022. Food and fuel make up a significant percentage of consumers’ budgets.
Energy and food prices have exploded on the back of the shift in US energy policy and the war in Ukraine, two supply-side economic events. Gasoline at over $5 and grain and oilseed prices at the highest levels since drought-ridden 2012 have a knock-on economic impact.
Last week, the US Federal Reserve hiked the short-term Fed Funds Rate by 75 basis points to 1.50% to 1.75% after the European Central Bank said it was ready for liftoff from years of negative interest rates. However, inflation levels will keep real rates in the US and Europe far below zero as inflation continues to erode money’s value. The US bond market has been in a bearish trend for the better part of a year, and higher rates are weighing on the stock market, with all the leading indices in negative territory in 2022. Meanwhile, the energy and food companies have bucked the market’s trend, posting substantial gains. The trend in interest rates is higher, but it is baked into the market’s psyche in June 2022.
The Fed cannot move too fast
- The Fed increased the Fed Funds rate by 75 basis points for the first time since 1994 at the June FOMC meeting from 1.50% to 1.75%.
- The statement and press conference were moderately hawkish.
- The Fed is balancing addressing inflation and preventing a recession.
The mid-term elections are on the horizon
- The mid-term US elections in November make rate hikes and inflation problematic for the incumbents.
- Voters tend to cast ballots with their pocketbooks.
- The polls are not pretty for Democrats controlling the House of Representatives and the Senate.
- The outcome will set the stage for the 2024 Presidential contest and could divide the current ruling party in Washington DC.
The central banks are far behind the inflationary curve
- Inflation at the highest level since December 1981 makes a 1.50% to 1.75% Fed Funds Rate a drop in the bucket.
- Real US interest rates remain negative, fueling inflation.
- The Fed waited far too long to get hawkish.
The Fed and ECB do not have the answers to the current issues facing the economy
- In 2020 and 2021, liquidity and stimulus stabilized the economy during the pandemic.
- The 2022 war in Ukraine created supply-side economic problems.
- Central banks do not have practical tools for the economy’s supply side.
Expect more market volatility for at least four reasons
- Reason one- Geopolitical tensions are fueling volatility.
- Reason two- Energy prices are a supply, not a demand-side issue.
- Reason three- Bullish stock market trends of the past years have turned bearish; whack-a-mole conditions persist.
- Reason four- Sentiment and consumer confidence is ugly, a sign of recession. Another quarter of negative GDP will cement the economic condition.
Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!