The Biggest Driver of Uncertainty
Let’s get to what’s driving the markets, causing stocks to sink, crypto to crater and interest rates to rise: uncertainty over inflation. But it’s not just that, it’s about the reaction to inflation.
When will the Federal Reserve raise interest rates?
As I’ve been writing, the rise in prices across the globe and in the US has been spectacular. What’s been surprising has been the sanguine or “What-me-worry” approach by both the US central bank and many top name economists. This has now changed as country after country has reported faster inflation on a wide range of products and inputs. One of the biggest increases/shortages is with semiconductor chips. Cisco reported earnings and had a miss on their margins due to increased prices in chips.
This leads us to what happened yesterday. At the April 28th meeting, the Fed statement confirmed that inflation was not a worry, “Inflation has risen, largely reflecting transitory factors.” Despite not worrying about inflation, the minutes mention inflation 55 times. But the fun starts with language buried in the minutes released yesterday.
Here’s a few key points:
- A number of participants remarked that supply chain bottlenecks and input shortages may not be resolved quickly and, if so, these factors could put upward pressure on prices beyond this year.
- They noted that in some industries, supply chain disruptions appeared to be more persistent than originally anticipated and reportedly had led to higher input costs.
- A number of participants suggested that if the economy continued to make rapid progress toward the Committee’s goals, it might be appropriate at some point in upcoming meetings to begin discussing a plan for adjusting the pace of asset purchases. (my italics)
The markets were “surprised” by the mere mention of a potential shift in discussion on inflation. Yes, the thinking about thinking about talking about inflation. For the record, no one said taper. At least, not out loud. But c’mon! On May 6th, Dallas Fed President Rob Kaplan said he wants the central bank to start talking about reducing policy accommodation “sooner rather than later,” saying the economy has improved faster than he expected, and citing worries about excesses and imbalances in markets. This isn’t new news people and today’s rally back in stocks/bonds demonstrates it.
Keep in mind, it is a big deal. Tapering or reducing down the number of securities the central bank purchases is the beginning of the process of reducing monetary stimulus. Given the 2013 “taper tantrum” or when interest rates rose rapidly, the Fed and markets are quite focused on the genesis of the process. The current ultra-easy monetary policy coupled with an ultra-stimulatory fiscal policy has driven up the economy resulting in 6.0%+ GDP, a rapid decline in the unemployment rate and a significant rise in inflation.
It has also led to a significant increase in the US stock market, significant increase in US housing prices and a significant increase in speculation including NFTs and crypto currencies. This is why the world is keenly focused on a sniff of a change in this ultra-easy monetary and fiscal policy. The market reaction yesterday is emblematic of this as US bond rates rose rapidly BTC had a wipeout and equities sank. If interest rates continue to climb, we will see another victim: housing. I’m not sure where this will hit, but a warning sign is how the stock prices of companies in this space like Lennar, Lowe’s and Home Depot have recently stalled or sank.
Going forward, we’ll all be watching the next meeting of the Federal Reserve, on June 15-16, to learn more about their views on talking about talking about tapering. They should start the process of giving the markets and businesses an indication of what a future shift would begin with on reducing the stimulus they are currently providing. Clearly, the cracks in the wild financial speculation are happening. For now, the interest rate markets will begin pricing when they think this will occur and it looks like November.
Stating the obvious, a lot is riding on this change. The history of the Fed is they wait too long to act and then overreact or act too late. I don’t see a change to this behavior. Volatile markets evince the uncertain sentiment surrounding this initial phase to the adjustment process.