Inflation,
Markets, Fed Policy, Elections and War in Ukraine
By Victor
Sperandeo with the Curmudgeon
Introduction:
Just the facts Maam is the theme of this
article. That quote is from the popular Dragnet TV series, which aired from
1951-to-1959.
CPI History:
The BLS definition and components of the Consumer
Price Index (CPI) have been changed many times over the years to make it
more politically friendly. Using just
the facts from 1913 to date we find:
- From 1791 (U.S.
on the Gold standard) to 1913, prices rose 0.12% per year.
- From 1913 to 2022
(or 109 years and 2 months), the CPI compounded at 3.11%. GOLD compounded at 4.25% during that
same period.
- From August 1971
(after Nixon took the U.S. off the Gold standard) to 2022, the CPI
compounded at 3.91%.
- The current
year-over- year CPI (ending in February 2022) was + 7.9%.
Market Drivers:
Today, price rises created from inflation (the
increase in the M2 money supply) and shortages from supply chain disruptions
are driving the markets. The uncertainty
from the Russia-Ukraine war is a close second.
Based on these fundamentals and technical analysis, I
reiterate that U.S. stocks are in a Bear Market (re-confirmed with the
Dow Transports making a new low for the year on Friday, April 8th). The
secondary correction (bear market rally) from 3/8/22-to-3/29/22 is over, from
my observation.
Recession and Effect on U.S. and French Elections:
I believe the U.S. and the European Union (EU) are going into
a recession this year. Sharply rising
interest rates (see Consequences of Fed Policy below for details) are
cascading throughout the economy in the form of higher borrowing costs,
squeezing households and businesses alike. Car loans, credit cards and
corporate debt all stand to get more expensive as rates rise.
That implies that the U.S. mid-term elections in November
will be a big winner for the Republicans.
In a previous post, I wrote that the last time
there were six Fed rate increases in one year was 1994. The Dems lost 54 House
seats, 8 Senate seats, and 10 Governors.
Curmudgeon Note:
On Tuesday, Matthew Luzzetti, Deutsche
Bank's chief US economist wrote, "We no longer see the Fed achieving a
soft landing (i.e., the Fed raising rates just enough to control inflation
without causing a recession). Instead,
we anticipate that a more aggressive tightening of monetary policy will push
the U.S. economy into a recession."
Deutsche Bank is the first major Wall Street firm calling for
a recession and bear market in stocks. Luzzetti thinks this view will eventually become consensus.
--> For another perspective, please see BoAs hawkish Fed
forecast below.
...
In addition, the critical French elections second round
will be held on 4/24/22. It will be a
potential game changer for the EU and rest of the world.
Marine Le Pen (viewed as
a Donald Trump-like politician) has suddenly become a serious challenger to Emmanuel
Macron, the current President of France. Mr. Macron won the first-round election on
Sunday with 28.5% of the vote ahead of Ms. Le Pen with 24.2%, according to
polling firm Elabe. The French president now faces an
April 24th showdown with Ms. Le Pen that polls say will be much more tightly
contested than ever before.
Consequences of (future) Fed Monetary Policy:
Bonds are down more than stocks this year. Currently, the iShares TLT (20+ year
U.S. Bond) ETF is down -14.28%, while the iShares AGG (U.S. Aggregate
Bond) ETF is down -7.32% year to date.
For comparison, the SPDR S&P 500 SPY ETF is down -5.23% year
to date (Source: Yahoo Finance).
At the beginning of 2022, the average interest rate on a 30-year
mortgage was about 3%. Today it
stands at 4.72%, according to Freddie Mac. That translates into sharply higher
borrowing costs for Americans looking to buy a home. The 30-year mortgage rate is tethered to the
yield on the 10-year Treasury note, which has increased to 2.715% in
anticipation of future Fed Funds rate increases.
Meanwhile, the 2-year T note yield has climbed to
2.516% as per this one-year chart:
The 10- and 30-year Treasury bond yields are 2.715% and
2.746%, respectively. Combined with the 2-year yield, we have a very flat
yield curve. (Source: Market Watch.com)
Summing up, bonds of all types continue to decline as the
FOMC members bash the debt market with threats of much higher interest rates to
come and talk of Quantitative Tightening (QT) to reduce the Feds
balance sheet.
BofA Global Research on Fed Rate Hikes:
BofAs U.S.
Economics team has raised its expectations
for Fed rate hikes. They are now looking for 50bps hikes in each of the next
three meetings, with 25bps thereafter and a terminal Fed Funds rate
of 3.25-3.50%. Thats 25bps higher than
its prior forecast.
BofA believes that risks to their Fed forecast are tilted to
the upside. If inflation looks like it is heading below 3%, then their current
call should be hawkish enough. Conversely, if inflation gets stuck above 3%
then the Fed will need to raise rates until growth drops close to zero, risking
a recession.
The bank expects inflation to peak with the March CPI and the
rates team suggests this peak likely means a risk of lower nominal yields as
inflation moderates. BofA is comfortable with its forecast of a 2.5% 10-Year T
note yield by year-end 2022.
Geopolitical Strains and the Russia Ukraine War:
Energy and food shortages are beginning to cause riots in
some nations. For example, in Peru over
food prices and in debt laden Sri Lanka over power blackouts.
More importantly, the Russia-Ukraine war is escalating. Asset manager BlackRock maintains the
likelihood of a Russia-NATO conflict is at a high level, even as the
U.S. and its allies are working hard to prevent it.
The global BlackRock Geopolitical Risk Indicator
(shown below) attempts to capture the market attention to geopolitical risks.
Their overall geopolitical risk indicator has spiked to its highest level in
more than a year. This is driven by elevated market attention to
conflict-related risks generally, and Russia-NATO conflict specifically.
Source: BlackRock
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Up till now, theres been no serious talk of peace from any
of the Western Nations, e.g., the U.S., UK, or the EU. However, that may be changing based on UK
Prime Minister Boris Johnsons surprise visit to Ukraine on Saturday, April
9th. Calling Russias war on Ukraine
inexcusable, Johnson pledged to intensify sanctions on Moscow, not just
freezing assets in banks and sanctioning oligarchs but moving away from the use
of Russian hydrocarbons. He also promised Britains help with clearing mines
left behind by Russian forces and said Britain would liberalize trade with
Ukraine.
What this war is certainly producing is a clarity about a
vision for the future of Ukraine, where together with friends and partners, we,
the U.K., and others, supply the equipment, the technology, the know-how, the
intelligence, so that Ukraine will never be invaded again so that Ukraine is
so fortified and so protected that Ukraine can never be bullied again, never be
blackmailed again, never be threatened in the same way again, Johnson said at
the news conference alongside Ukraine President Volodymyr Zelensky.
Last week, U.S. Chairman of the Joint Chiefs of Staff Mark A Milley warned of a prolonged
conflict in Ukraine that could take years to end. I think NATO, the United
States, Ukraine and all the allies and allies that support Ukraine are going to
be involved for some time, Milley, the top U.S. military official, told the
House Armed Services Committee.
No Nuclear Weapons!
Also, talk of nuclear weapons being used by Russia is
insanity to the 10th power. One nuclear bomb would take civilization back 75+
years. Anyone who mentions using Nukes
is a complete nihilist and should be arrested for crimes against humanity
(Curmudgeon: as is the case with Russias
persistent bombing and killing civilians in Ukraine).
Who will win a conventional (non-nuclear) war in
Ukraine? One classic slogan is:
God is on the side of the big battalions. George Bernard Shaw,
However, no winners would exist if nuclear weapons were to be
used.
Conclusions:
The first quarter of 2022 was one of the most volatile and
difficult quarters in my 56-year career as a financial professional (starting
in January 1966). The reason is the multitude of different factors affecting
all the markets at the same time.
The coronavirus surges, high inflation, a multi -faceted war,
a likely recession due to dramatic Fed Policy changes, a flat or inverted yield
curve, a major debt market decline, all punctuated by weak political leaders
more interested in power than the people they were elected to serve. Its been very challenging to live through
all of this!
Cartoon of the Week:
End Quote:
Perhaps these words are worth thinking about now:
He who has a why to live for can bear almost any
how.
Stay healthy, enjoy life, success, good luck, and best
wishes. Till next time....
The Curmudgeon
ajwdct@gmail.com
Follow the Curmudgeon on Twitter @ajwdct247
Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.
Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies, and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.
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