Russia, The Fed & Inflation
There is a lot to discuss so I will dispense with the pleasantries and jump right in.
Russia/Ukraine
If you didn’t get a chance to read my note on Russia/Ukraine from last evening click here. One of the key takeaways was that historically stocks tend to go down in advance of the conflict and rally soon after the invasion/war begins.
While the invasion is very difficult for the people of Ukraine, our job is also to be looking at the economic impact. Ukraine’s GDP is $185 billion. That is equal to about 16 weeks of sales at Walmart.
Prices of oil and natural gas could move higher in the short run. That said, prices for both had already made sharp moves higher due to supply/demand imbalances.
There are those who believe that China’s President Xi is watching to see how the U.S and Europe will respond to Russia. If China does make a move on Taiwan that would have a larger economic impact, especially on the semiconductor space.
The Fed
More Fed members have come out in the last few weeks and acknowledged that the Fed needs to hike intertest rates quickly. Currently markets are pricing in seven rate increases in 2022. Also, Fed Futures pricing has the odds of a .50 rate increase in March at 34%.
Fundstrat put together the chart below which shows that the market has frequently over-estimated the number of rate hikes from the Fed.
If this is again the case, that will be very bullish for stocks as we get later in the year.
Inflation
Last month we highlighted that inflation came in at over 7%, a 40 year high. January’s reading, announced two weeks ago, saw the latest CPI reading come in at a new 40 year high of 7.5%.
The Producer Price Index, which measures wholesale prices, came in at 9.7% higher vs one year ago.
The Fed’s policy mistake of referring to inflation last year as “transitory” and believing it would quickly recede back to 2% continues to be a major problem.
While Russia is currently dominating news coverage, we believe that the biggest factor impacting the financial markets will be the path that the Fed chooses to take when they meet on March 15th & 16th. Specifically, do they raise interest rates by .25 or .50? Do they saying anything to reaffirm the market’s current belief that up to seven rate hikes are in the cards? And last, but certainly not least, when do they begin to reduce their $9 trillion balance sheet and at what pace will they prefer to move?
We have seen nothing to change our prior opinion that in 2022 financial markets would face higher volatility, similar to 2018. The good news is the jobs market is incredibly strong, consumers still have a lot of cash to spend and company earnings have continued to be very good. Lastly, we leave you with the chart of the Nasdaq. The January decline bottomed on the 24th. After a two week bounce off that low, the Nasdaq has moved lower and the retest of the Jan 24th lows has begun. The bigger test will be the one Fed Chair Jerome Powell will be taking March 15th & 16th. We will be watching!
