Are the US financial markets about to awaken from the comfortable slumber of prolonged sequences of positive, slow grinds higher to more violent, turbulent bouts of negative realism: slumping valuations?
Tomorrow evening’s FOMC rate decision isn’t expected to shake the markets quite yet. Consensus points to a continued stagnation in the Federal Fund Rate of 0.25%. Where the real story could unfold is in the accompanying statement and subsequent press conference. For some time, the Federal Reserve has treated the inflationary threat as transitory with the US economy set to recover well from the enforced covid pandemic lockdown. Despite this continued upbeat assessment, it makes sense from a risk perspective that we are alert to adjustments to this well-trodden narrative, written or spoken, no matter how small or innocuous, that could send worried investors scrambling full flight to financial safety.
The Chairman of the Federal Reserve, Jerome Powell, has maintained consistently that interest rates will be kept low and accommodating. A revision to the rate is therefore not expected. However, the first seismic shock to the US system is almost certain to be a tapering of the asset purchase program which continues apace at $120 billions per month. How this is introduced and the details of the tapering are unimportant; the fact that the Federal Reserve indicates it is willing to tighten monetary policy is all that is needed to trigger a collapse in already bloated share and asset price valuations. Powell is bound to dress-up any negative news to be much more innocent than it really is – see below.
We do not expect any of this to happen just yet. A much more likely timing is the Jackson Hole Annual Economic Symposium, scheduled for the tail end of August. This attracts central bankers, policy makers, academics and economists, giving the Federal Reserve a chance to secure global support and concerted action by all
Facts on the ground suggest that inflation is more entrenched than the Federal Reserve is prepared to admit and is most likely to force the change in US monetary policy at some point. The latest reading of CPI, which includes groceries, energy, housing and general sales soared during the first half of 2021 from a January low of 1.4% to 5% in May. This is the highest reading since August 2008 when the economy suffered the worst recession since the time of the Great Depression. Worryingly, core CPI rose 3.8%, the most since 1992! In fact, the last 3-months combined pace suggests annualised inflation at over 8%!
CPI is in any case not a reliable indicator of real inflationary pressures since it has been reformulated multiple times to paint the best possible ‘political’ picture. According to some analysts if the same methods of assessments were used as in the 1980s and the 1990s, the inflation rate would be 13% and 8% respectively. Historically, since 1913 when the Central Bank was created cumulative inflation is 2,525% meaning that a product priced then at $1.00 would cost over $26 today!
Headline figures may look soft and manageable, but the real damage is felt in everyday living expenses. There is no concealing the truth from the consumer. Their plight is not helped as companies are passing on the full elevated costs of commodities to the end user with some creative financial reporting descriptions: ‘strategic revenue management’ and holistic margin management’. How long this can continue is debatable after which corporate earnings and revenues are going to suffer sharply.
One of the significant contributors to the inflationary pressures is the unprecedented sheer scale by which new money is being printed: unconventional monetary measures. Here are some sharp facts.
The key to watch in the coming months is the inflation rate which could trigger a slower pace in easy money making for much tighter policy measures and economic activity. This will inevitably spook investors and the markets. But this is going to be pushed back as far as possible and explains why we are so interested in the Jackson Hole symposium
If the next inflation readout shows a softer pace of 4% expect the Federal Reserve fanfare of declaring they were right when insisting that the pressures were transitory. However, you know that the significant decline in US dollar purchasing power is what hits the US consumer hard. Headlines don’t pay the checkout bill at the local supermarket!
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