Preparing for Impact – PPI Surges

Never a dull night on global markets lately… Last night was again a sea of red.  The only green was yet again the US dollar (at near 20 year highs) and big cap crypto (coming off massive falls).  The S&P500 rallied a little late to avoid falling into an official bear market (20% off recent highs) by just 2bps and the NASDAQ long left the bear market station down 32% and now its biggest fall since the GFC.  Gold and silver broke their hold and both fell sharply on the night, possibly due to liquidations to pay up margin calls on shares.  With bond yields plummeting and inflation raging that of course makes no sense for precious metals that LOVE a negative real interest rate and market turmoil.

However in a market where the other big liquid market of crypto has fallen so sharply, gold stands prominently as a beautifully liquid market that has held strong relative to the carnage around it. Margin call money has to come from somewhere…

The night was notable for a strong indicator that inflation isn’t going anywhere soon with the US ‘factory door’ PPI print coming in higher than expected at an eye watering 11%, up another 0.5% in just one month.

The following meme puts the situation into clear perspective…

Yesterday we spoke to the 8.3% CPI print and those with even a rudimentary appreciation of math will see the problem here.  As the chart below shows, when prices are going up 8.3% and input costs for those goods up 11.3% that either means prices go up more or the companies producing them have reduced margins.  Margins equal earnings and earnings in a normal world are how shares are valued.  For 16 straight months now, that has been the case:

Valuations, even after this rout are historically high so there is PLENTY of scope for further falls.

And hence the question on everyone’s lips and the scrutiny of every word from the Fed’s mouth pieces is how committed are they to keep hiking when just a mere 0.75% rate rise has crashed markets?

Last night, at the end of the market’s day, the head honcho himself, US Fed Chair Powell gave some insight to this in an interview with MarketPlace Radio where he admitted a soft landing is something they “don’t control”. Here are some excerpts that are well worth reading for some insight:

“But what would I say to that person? So I would say that we fully understand and appreciate how painful inflation is, and that we have the tools and the resolve to get it down to 2%, and that we’re going to do that. I will also say that the process of getting inflation down to 2% will also include some pain, but ultimately the most painful thing would be if we were to fail to deal with it and inflation were to get entrenched in the economy at high levels, and we know what that’s like. And that’s just people losing the value of their paycheck to high inflation and, ultimately, we’d have to go through a much deeper downturn. And so we really need to avoid that.”

And whilst they have tried to calm the market with assurances a 75bps hike is ‘off the table’:

“Powell: “If things come in better than we expect, then we’re prepared to do less, if they come in worse than when we expect, then we’re prepared to do more.”

Interviewer: Let me be clear, 75-basis points is “prepared to do more?”

Powell: What you’ve seen is, you’ve seen this committee adapt to the incoming data and the evolving outlook. And that’s what we’ll continue to do.”

And for all the “the Fed’s got this” proponents that like all previous corrections since the GFC has seen the Fed come in to the rescue…

““There are huge events, geopolitical events going on around the world, that are going to play a very important role in the economy in the next year or so……So the question whether we can execute a soft landing or not, it may actually depend on factors that we don’t control.”

And so the well worn playbook of raising rates till something breaks and then quickly reverse to save the day may well be tested further this time.  Just remember there are multiple factors at play though.  Whilst the Fed may not lower their Fed Funds Rate or rotate from QT back to QE, the market can and has taken yields into their own hands and the analogy of the dam wall starting to fail and the Fed’s various fingers in various holes looms large.  In 2018 we saw (but many did not fully appreciate) the REPO crisis playing out behind the scenes of just ‘rates’ and ‘QE’. There is an unprecedented body of debt behind that dam wall facing surging inflationary pressures.  The Fed has only so many fingers in an incredibly complex matrix of global financial markets, currencies, derivatives, debt instruments, demographics and disruptive change.  Always, always remember Exters Pyramid and protect your wealth.