Inflation Continues To Drive Interest Rates Higher

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Image: Federal Reserve Chair Jerome Powell, July 27, 2022. Source: Federal Reserve / Flickr

While stocks and commodity prices retreated in June, the consumer and producer price index data continued to signal the worst inflation in over four decades. The June consumer price index rose 9.1%, above the 8.8% consensus forecast. Core CPI, excluding food and energy prices, rose 5.9% compared with the 5.7% estimate. With the Fed Funds Rate sitting at the 1.50% to 1.75% level, inflation continues to rage.

Moreover, the highest food and energy prices in years filter through to the rest of the economy, and there are supply-side economic issues as the war in Ukraine has pushed traditional energy and agricultural commodity prices higher.

 

Meanwhile, the June producer price index revealed wholesale prices rose 11.3% from a year ago, near the record 11.6% gain from March 2022. The bottom line is that inflation continues to support higher US interest rates, with the Federal Reserve increasing the Fed Funds rate by at another 75 basis points this week.

Q2 GDP data released Thursday showed a 0.9% annual decline, confirming the US economy is in a recession. Q1 GDP contracted, and two consecutive negative readings is the textbook definition of a recession.

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Recession and inflation = Stagflation

  • The 0.9% decline in annual GDP in Q2 2022 is the second consecutive US economic contraction, signaling a recession.
  • Based on the June consumer and producer price indices, inflation remains at a four-decade high.
  • In economics, recession plus inflation equals stagflation.

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The Fed is caught between a rock and a hard place

  • The Federal Reserve raised the Fed Funds Rate another 75 basis points at the July FOMC meeting.
  • The hike pushes the short-term rate to a range of 2.25% to 2.50%, well below the recent CPI and PPI readings and less than half of the core levels.
  • Rising interest rates may dampen inflation but also weigh on economic growth, exacerbating recessionary pressures.

A trip to the Middle East does not solve the energy issue

  • Fourteen-year highs in fossil fuel prices are a supply-side economic problem beyond the reach of the central bank’s monetary policy toolbox.
  • President Joe Biden recently traveled to Saudi Arabia to encourage the Saudis and their OPEC partners to increase crude oil production to address high prices.
  • The Saudis intend to monitor the global demand and remain on the same production path in coordination with other cartel members.
  • The President’s trip did not achieve the desired results, and nearby NYMEX crude oil prices moved back over the $100 per barrel level in the aftermath of the visit.

Russia is using energy as a weapon against the US and Europe

  • Russia is a leading oil and gas producing country, supplying Europe and other consumers worldwide.
  • Russia stated it would respond to sanctions and those “unfriendly” countries supporting Ukraine with limits or bans on traditional energy supplies.
  • Crude oil, gas, and coal exports from Russia have become weapons in the deteriorating geopolitical landscape.

Mid-term elections could cause a power shift- Lots of market volatility on the horizon

  • One of the primary pledges in President Biden’s platform was addressing climate change and limiting fossil fuel production and consumption.
  • Rising inflation, US energy policy, and the war in Ukraine have caused oil, gas, and coal prices to soar.
  • Historically, inflation and high energy prices do not support incumbent US candidates for government offices.
  • The mid-term elections in November 2022 could cause the Republicans to regain majorities in the House of Representatives and the Senate, making the current administration a lame-duck when it comes to policy initiatives.
  • A power shift could change US energy policy, causing volatility in traditional energy markets and markets across all asset classes.

Thanks for reading, and stay tuned for the next edition of the Tradier Rundown!

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Equities News Contributor: Tradier Inc.

Source: Equities News

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