Should We Be Worried About Inflation?
All Eyes on the Upcoming Fed Meeting
With interest rates and inflation being the main concern for investors these days, all eyes will be on the Federal Reserve's interest rate decision coming this Wednesday.
Many analysts are calling for a resurgence in inflation. While the Federal Reserve has been standing by their word, saying that inflation is under control and we are on the path towards rate cuts this year.
If the Fed believes that inflation is no longer falling, then they might hold rates at these levels for longer. If we experience a resurgence in inflation, then the Fed might even raise rates again.
One thing to be cautious about is the fact that investors are expecting rate cuts this year. So, if they don't get the rate cuts that they have already priced into the market, then that could possibly alleviate some of the extreme bullihness we have been seeing for several months.
Energy vs. Inflation
By far, the most important contributors to inflation are energy prices. Recently, the major components that affect energy, like oil prices and fuel prices, have been climbing. This will add upward pressure to inflation numbers.
I mentioned a potential rise in oil prices several weeks ago in a previous post. Crude is up over 10% since then. Check out my comments in the link directly below.
All-Encompassing Oil
The price of just about everything in an economy is affected by commodities prices, and more specificaly oil prices.
Oil or oil byproducts are involved in almost every aspect in the life cycle of a product or service. From production, transportation, consumption, and the facilitation of the use of a product or service. Oil is in just about everything. So, oil prices probably have the biggest impact on inflation and/or the prices of goods and services.
The Federal Reserve has stated that when they are determining their interest rate decisions, they put less weight on the more volatile commodities like food and energy as these prices can change at a moments notice. But when talking about inflation, you can't ignore energy and fuel prices. If these get too expensive, then there is no stopping the rise in core inflation, which is the inflation metric that the Fed closely follows.
Oil and Gas Rally
Oil prices and fuel prices have been on the rise over the past few months due to the ongoing conflict in Russia and the continued production cuts by OPEC.
You can see in the chart below how oil prices have been climbing in an almost perfect price channel for a few months. If this trend continues, then it is almost certain that inflation will climb as well. As long as the price action of crude stays above the support line of this channel, then inflationary pressure will remain.
The outlook for fuel prices looks even more inflationary. I am feeling the pain at the pump myself.
Russia recently banned gasoline exports to the US. This caused a huge gap up overnight and pushed up fuel prices to the highest they had been in four months. This is very concerning to anybody who is worried about inflation. To add to the worries, gasoline futures rallied all week last week.
From a technical standpoint, the over three month rally looks quite bullish as the price action has climbed above a long-term trending resistance level. This is concerning when talking about inflation. But before any long-term uptrend can be considered, we need to see the price climb above the horizontal resistance levels I've highlighted in the chart directly below. We need to see a rejection at these resistance levels to alleviate any fears of inflation.
Industrial Metals Rally
Here is an example of some industrial metals that have been climbing over the past month, which adds to inflation as well. And remember that energy and fuel prices are partially contributing to the increases in these commodity prices.
Rallying Commodity ETFs
Some ETFs that track a basket of highly traded industrial, aggricultural, and energy commodities have been on the rise as well. It is interesting to see the very large volume spikes that occurred near the lows just before these ETFs started rallying. This tells me that there is substance to the rally as many investors were expecting it.
Higher Commodities Prices Present Investment Opportunities
One commodity that has been on a meteoric rise is cocao. This commodity has a very miniscule effect on the Feds interest rate decision, but a skyrocketing commodity price, like cocao and other commodities, can provide great investment opportunities in companies with exposure to the commodity.
Companies that have exposure to the higher commodities prices are likely to pass their higher input costs onto their consumers. This will likely equate to higher earnings numbers. This is why some economist believe that inflation is good for equity markets. Occasionally, if margins are not affected by the sky-high commodities prices, then this can result in bullish investor sentiment.
Because of the rocketing cocao price, I jumped into a long position in HSY. I did this for technical reasons and in expectation of higher earnings numbers due to higher cocao prices. I mentioned this position change in a previous post. Check it out in the link directly below.
Conclusion
Inflation has been worrying investors over the past couple of months. Commodities prices, like energy prices, have been on an uptick. Personally, this is the most worrying aspect for me. But ultimately, it doesn't matter what myself or any other investor thinks. Currently, when it comes to equity markets, the only thing that matters is what the Fed is going to do.
So, for equity markets, this Wednesday will be the most important day for investors. Will the Fed hold rates higher for longer? Will they announced a schedule for rate cuts? Heck, there is always a tiny possibility that they could hike rates, but I doubt it.
Personally I believe that the economy is in the perfect spot for the Fed to successfully achieve their dual mandate. So, they have no reason to make any changes to monetary policy until something breaks.
So, what do you think that the Fed will do this Wednesday? Will they hold current rates and mention no cuts for this year? Or will they hold rates and mention cuts later this year? Or will they cut rates at this next meeting, or hike rates rates at the next meeting?
Good Luck Trading
As always, I am not a financial professional, and this is not investment advice. Be careful and be patient. Dont anticipate the market. Rather, participate in the market. Don't invest money that you can't afford to lose. Give some of your investments time and know when to cut your losses.
Don't be greedy. Don't invest in anything you don't understand. Don't put all of your eggs in one basket. Don't listen to the hype. Don't fomo or panic into or out of trades. Do your own due diligence. And just follow the trends. A trend is your friend. Good luck trading.
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BelleWeather : I think proper portfolio positioning vis a vis inflation is important. The concern I have is stagflation, so I’m trying to be defensive to that. This is difficult. And timing the market is impossible and crazy-making, so I personally am taking each day as it comes.
I don’t think anyone is going to sell off over these concerns, and Powell is not about to fan those flames either!
SpyderCallOP BelleWeather: They might not sell over these concerns. But when these variables are present, then any negative catalyst will likely catalyze a selloff. For example, if we get bad rhetoric from Powell next week, then we might see extra volatility. That being said, in the current environment, any selloff will be a good buying opportunity until something breaks in the economy.
SpyderCallOP BelleWeather: So far, wages and employment numbers have held up, so stagflation is not a concern until inflation picks back up. With the way oil and gasoline prices have been climbing, we could possibly see a stagflationary environment soon, but not yet. Things are almost perfect in the economic data currently. We are in a goldilocks zone for the Fed right now. And if things get worse, then the Fed has already mentioned cutting rates. That would be even more accomodative for equities as the "Fed Put" will be in play at that point. So, if we do see stagflation, it shouldn't last long as the Fed will accommodate markets when the inflation, wages, or employment situation changes negatively.
BelleWeather : Agreed on the Goldilocks zone vis a vis the Fed mandate save one issue - the reserve bank balance is almost out - won’t they have to move to correct that?
SpyderCallOP BelleWeather: They have been greatly decreasing the balance sheet since march 2022. This is done through selling treasury bonds or mortgage securities. Short-term treasuries, like bills, have been the biggest culprits for the runoff of the balance sheet. This has been unwinding the massive amount of asset purchases since the 2008 financial crisis.
They purchased all of these assets back then as a form of quantative easing to boost the economy. Right now, they are selling treasury notes at sky-high yields to provide liquidity to banks essentially. This is putting more liabilities onto the balance sheet, which brings the balance down.
I don't think the balance sheet runoff is such a big deal at the moment.
Once the economy is showing signs of trouble, then I think we will need to worry about the Fed balance sheet. If they start buying assets, essentially quantative easing, then they might think that there is weakness in the economy.
You might think that with the Fed balance falling like it is, then long-term treasuries should be falling along with the balance. But that has not been the case since last November as these treasuries have been climbing.
This tells me that the balance sheet is now falling because the Fed is adding liquidity through short-term bond sales, which inject liquidity into the economy, which is good for an economy and equities.
SpyderCallOP BelleWeather: Based on how the economy, equity markets, and the bond market are performing, this is how I perceive the bank balance sheet right now. But then again, I don't thoroughly analyze the Fed balance sheet like an investment bank would. So, I could be completely wrong.
BelleWeather SpyderCallOP: Yes, this stuff gets convoluted and is well beyond my circle of competence. Also, there isn’t much I can do except bulwark portfolios against all possibilities (which is what I imagine I should be doing anyway - a black swan could land at any moment and my BTC gamble could implode, for example.)
SpyderCallOP BelleWeather: Indeed, a black swan could hit at any moment. But I've noticed that the market will not react to the black swan event until the economy is well into the event. Like the market won't even notice until "the devil is at the door," so to speak.
Of course, if you get defensive ahead of any black swan or recession, then you would benefit a lot more. But personally, with all of the constant negative media, even when the market is doing great, I don't react to any bad news until the market does. I am a more reactive investor than a defensive one.
BelleWeather SpyderCallOP: I agree with all you’ve said, and also may be wrong. It’s the bank reserve I wonder about but I’m not sure What even understand that. It’s a wonderful time to be invested, for sure. I wish the presidential election weren’t so soon as that may slow or stop the bull by 2025. But again, I may not comprehend, be wrong and there’s little I can do anyway.
BelleWeather SpyderCallOP: I think that’s wise and will maximize returns. I wish I’d been quicker on my feet in March 2020 - that was a great sale! But I’d not had the cash and was afraid of margin (regret that now.) I believe reacting is better than preparing for all possibilities, actually. And investments in various things have the same effect. Like I think water is getting critical and utilities are on sale now and water treatment was during the 2023 uptick - those present opportunities that happen to both give great returns and be defensive. The media is hysterical and people sitting in cash always lose in general, so taking things as they come is wise, I think. And there are always more opportunities than capital to allocate to them (but now I can start using TA to compare and visualize the differences between strong candidates’ uptrends.) I find it odd how frequently people say there’s nothing attractively valued because the market is up, or don’t want to join in due to an anticipated crash that may not happen for a long time and leaves money on the table in the interim. (I’d prefer a 20% correction on 100% gains, myself.) Was the 2020 black swan some you were able to take advantage of?
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