Sick of Inflation?

I haven’t heard inflation discussed so much since I was a kid in the 1970s. The adults talked about it all the time and I knew what inflation was by the time I was eight years old. It was about prices going higher. Unfortunately, this discussion will last a bit longer but there is the potential for some high drama next week.

Let’s review. The Fed went bananas with stimulus during COVID which caused prices to rise when the economy re-opened so they needed to dramatically raise interest rates to stem price increases. They realized their mistake too late.

The Fed also said that they would stop hiking rates when inflation looked to be about 2%. Last Fall, they said things were better and hinted that relief in 2024 with rate cuts might happen which caused the equity market to about-face from a three month correction. Many economists were soon predicting up to 6 rate cuts in 2024 beginning at the Fed’s March meeting. And now that meeting is upon us this Wednesday.

Consumer Prices by @wsj

Did we get to 2%? Not for consumer prices which came in at 3.2% this week, however, producer prices were reported at 1.6%. The bad news is that both of these numbers have come in higher than the market expected over the last two months. And there is mounting evidence prices may rise again although it is a little early to make that call. The consensus now is that a 25bp rate cut may happen at the July meeting.

Yield Curve

There are two camps right now. There are those that believe the current level of interest rates will cause a default cycle and those that see growth in areas like technology that will keep the economy in good shape. Both views have credibility which may mean the Fed does nothing until one side has a stronger signal.

If we look at how the bond market is trading, we can see rates shifting higher as denoted by the blue line in the chart below. Notable is the rise in the 1Yr that closed at 5.08% on Friday and that indicates 1-2 rate cuts so the yield curve is pricing a longer time frame for a rate cut – maybe next year. Where will the 1Yr trade after Wednesday? By the way, the closing yields on Friday for 5Yr & 10Yr Treasury bonds were the highest since last November.

Yield Curve by @kiscocap

Commodities Prices Rising

In the chart below we have crude oil, 10Yr bond yields and the CRB Commodities Index which is comprised of Energy: 39%, Agriculture: 41%, Precious Metals: 7%, Base/Industrial Metals: 13%. This chart warns of rising inflation expectations among the inputs to production which translates to higher prices for you and me.

The S&P 500

The pivot higher from the October 2023 low in this chart was the beginning of the rate-cut mania that is now getting religion. There has been virtually no corrective action for months so stocks are due for a pullback and we can see the momentum indicators at the bottom of the chart are starting to hook lower.

S&P 500 by @kiscocap

The market could consolidate here and trade sideways. However, the inflation data may force the Fed to message differently about rate cuts and that sets up the stock market to adjust to less than accommodative path of interest rates.

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Paul McCarthy, President of Kisco Capital, LLC

Good luck out there!

Paul J McCarthy III CFA

President, Kisco Capital

Paul McCarthy

Mr. McCarthy is the President and founder of Kisco Capital.