Change In ‘Fedspeak’ Triggers Rally
Following last week’s Federal Open Market Committee (FOMC) meeting, Fed Chairman Jerome Powell held his press conference, where his answer to the first question asked of him was the spark that lit the fire under the market that carried the rally right into Friday’s closing bell.
To be clear, words matter, and Powell chose his words carefully to where he repeated the one word that mattered most to the algorithms that trigger major moves for stocks. Jeanna Smialek of the New York Times led off the Q&A, asking Powell his thoughts on the Fed moving too aggressively and risking a recession or going too slowly and thereby allowing inflation to become fully embedded with the Fed falling even farther behind the curve.
Within the body of Powell’s response, the following statement triggered the rally.
“And so, all signs are that this is a strong economy and, indeed, one that will be able to flourish, not to say withstand but certainly flourish, as well, in the face of less accommodative monetary policy,” Powell said. “The American economy is very strong and well positioned to handle tighter monetary policy.”
From the Summary of Economic Projections release by the Fed following the FOMC meeting, the Fed is forecasting inflation ending the year at 4.3%, with the December read coming in at 2.6% and 2023 showing an annual inflation rate of 2.7%. Taking into account the current inflationary conditions, these projections seem more akin to fairy dust than reliable forecasting.
To get to these Goldilocks numbers, pretty much all has to be right with the world, and nothing could be further from such a rose-colored outlook. It is just amazing what the market gloms onto in search of any reason to ignite a set of broad-based buy programs in a market that is technically oversold, but not necessarily fundamentally so. A revisit of the FOMC statement shows a heightened level of uncertainty that acknowledges the depth of the risks to their optimism. A key comment in the FOMC statement:
“The invasion of Ukraine by Russia is causing tremendous human and economic hardship. The implications for the U.S. economy are highly uncertain, but in the near term the invasion and related events are likely to create additional upward pressure on inflation and weigh on economic activity.
“With appropriate firming in the stance of monetary policy, the Committee expects inflation to return to its 2 percent objective and the labor market to remain strong. That said, inflation is likely to take longer to return to our price stability goal than previously expected.
“Inflation remains well above our longer-run goal of 2 percent. Aggregate demand is strong, and bottlenecks and supply constraints are limiting how quickly production can respond. These supply disruptions have been larger and longer lasting than anticipated, exacerbated by waves of the virus here and abroad, and price pressures have spread to a broader range of goods and services.”
Additionally, higher energy prices are driving up overall inflation. The surge in prices of crude oil and other commodities that resulted from Russia’s invasion of Ukraine will put additional upward pressure on near-term inflation here at home in the United States.
Unfortunately, this assessment of inflation declining to 2.7% by the year’s end is, in my opinion, not in lock step with reality. The global supply chain constraints for Chinese-made goods have materially worsened with the lockdown of 50 million people in the high-tech city of Shenzhen and surrounding regions.
The lockdown is supposed to last only one week, but according to Dr. Scott Gottlieb, who serves on the board of Pfizer Inc. (NYSE: PFE), the renewed spread is due in part to the limited effectiveness of the vaccines China has deployed against the BA.2 omicron variant.
“They didn’t use the time that they bought themselves to really put in place measures that would prevent omicron from spreading,” Gottlieb said to CNBC.
The war in Ukraine is taking on the look and feel of Russia digging in for a prolonged siege on Kyiv and other key cities. Ukraine is the bread basket of that part of the world and accounts for roughly 10% of the global wheat and 16% of the global corn markets. If you add in Russia, wheat exports are 30%, and corn is over 20%. Russia is also the world’s largest producer of barley sugar beet and the third-largest global producer of potatoes.
The cutting off of Russian oil imports indefinitely by western nations will have long-term effects on gas, diesel, jet fuel, lubricants and all petroleum-based products found in just about every industry. China will serve as the main recipient of Russian oil, but Europe will freeze this coming winter without Russian natural gas supplies. To this point, U.S. exports to Europe for natural gas is a very attractive investment theme for 2022.
WTI crude is back up to around $105/bbl. after a brief pullback on hopes of a ceasefire, but it was reported by the Wall Street Journal that Russian President Vladimir Putin said he will continue the Ukraine invasion until the end. Additionally, President Biden’s phone call with President Xi was not successful. China did not condemn the invasion and did not promise that they would not undercut the sanctions on Russia.
In addition, the Wall Street Journal reported on March 8 that the “Saudis have signaled that their relationship with Washington has deteriorated under the Biden administration, and they want more support for their intervention in Yemen’s civil war, help with their own civilian nuclear program as Iran’s moves ahead, and legal immunity for Prince Mohammed in the U.S.” The Saudis aren’t picking up the phone, and that’s a problem for the future of oil prices.
Gas prices on a national level closed last Friday at $4.25/gallon, and could well exceed $5 if there are any disruptions at refineries and/or in the free flow of global oil shipments.
Jerome Powell and the Fed are painted into a corner. They appear to be in denial of the three-headed beast called inflation that will run hotter and longer than they want to admit, and if they raise rates too high, they imperil the national debt.
The finance charge on the $30 trillion owed by the government is about 1.6%, according to the Congressional Budget Office (CBO). For every 1% that finance charge goes up, it raises the cost of interest by $300 billion per year, by the CBO’s estimates. At 5%, that would add about another $1 trillion in interest due every year.
Mr. Powell’s favorite word used to be “transient,” and the market trusted him and rallied to new all-time highs. Today, his new favorite word is “flourish,” and the market fell in love with it last week as well.
In the movie “Margin Call,” about the collapse of Lehman Brothers, senior risk manager Eric Dale is fired and as the elevator door is about to close, he hands risk analyst Peter Sullivan a USB memory stick, says he was working on something and urges him to “be careful.”
The rest is history. I think going forward, given the current variables at work, investors should be careful about taking Fed Chair Jerome Powell at his word.
