Stocks closed moderately lower after a bumpy session as stock traders watched bond yields… closely. ISM data showed a larger than expected drop in its services index last month, proof that we are not out of the pandemic woods just yet.
N O T E W O R T H Y
Sometimes, less is more. I am taking an informal poll. How many times in the past 12 months have you heard the words “sorry, it’s because the supply chain problems, and you know, the COVID”? You usually hear that right after you are told that you must pay a ridiculous premium or that you have to wait longer for something you really need… and just paid a premium for. I have actually lost count of the number of times I have heard that. In fact, I heard it just yesterday about a dishwasher THAT I OVERPAID FOR. The store owner apologized for the longer than expected delay with a “sorry, you know the shortage of truck drivers and the supply chain problems.” Ok, ok, I get it, I understand it, and I know that it is a reality we are facing in the economy. Indeed, a principal driver of the inflation we have been experiencing are these oft-uttered supply chain logjams.
The other inflation driver, demand surge, is a whole other thing. Consumers have been rushing out to buy just about everything as the world is reopening. Stimulus checks and reduced spending during the toughest days of 2020 have caused household savings to rise, and consumers have been eager to drain those savings over the past 9 months. Sorry, I must go back to basics for a moment. When demand increases, prices go higher. Demand can be short term, longer term, or it can become persistent. Short term demand spikes are common when something that is hotly sought after is supply limited. We have witnessed these often in the pandemic with things like toilet paper, cleaning supplies, and more recently, COVID test kits. Supply is limited and demand for them is temporarily high, so consumers pay up. Demand surges can also be seasonal. The most prominent examples of this are surges in demand for gifts before the holidays, or school supplies in late August (or July, depending on where you live). Those demand surges result in price hikes. More on demand in just a few minutes.
Supply is the other side of the equation. If goods become scarce, even if demand remains constant, prices go higher as well. We have seen that in durable goods in past 12 months. Automobiles, for example, have experienced huge price spikes, principally driven by supply shortages. Consumers typically buy automobiles when a lease term ends or when their vehicles become inoperable, and not necessarily because they have saved a stimulus check. It is true that logistics are experiencing major glitches from shipping to trucking to stocking shelves. Lack of empty shipping containers, labor shortages on docks, and not enough drivers to get the containers that do get filled and offloaded to a local warehouse or store. The problem, of course, goes deeper. A 5,000-pound Ford F-150 cannot make it off the production line if a 2-gram microchip is not available to be installed in it. Microchips have been short in supply because of poor planning and COVID-related factory shutdowns. Missing chips and sub-assemblies have also caused production problems in consumer electronics (computers, gaming systems, etc.) and other consumer durables such as household appliances. A dishwasher can’t wash without semiconductors nor can a computer compute without a memory chip.
All these factors separately and together are causing prices to jump. We all recognize it and have felt those price hikes in our wallets in one way or another. So, the big question is how do we eradicate this inflation? That appears to be the job of the Federal Reserve. In fact, it is ½ of its dual mandate. Lately, the Fed has been taking that very seriously, as it should, with recent record-breaking price jumps. We know the Fed is serious because it has lowered the amount of bonds it buys every month, and it in fact recently decided to speed up the rate of its tapering. Pressure on the bond market should push bond yields and the lending costs attached to them higher, which should ultimately dampen demand and inflation. This week, we got a glimpse into the Fed’s debate on inflation fighting in its FOMC meeting minutes. The minutes showed that the Fed was not only considering halting bond purchases earlier than expected, but also considering balance sheet runoff. That is a fancy term for the Fed’s selling bonds. If buying less bonds causes yields to rise, imagine what selling will do to them. For the record, the Fed has some $8.7 trillion of bonds on its balance sheet… that’s a lot. In addition to the balance sheet runoff, some Fed members would like to see rate hikes come sooner than the formerly expected liftoff date this summer. All of this is textbook economics. The Fed bankers are under intense political pressure to do something, anything to fight this horrid inflation. I used italics to underscore my use of hyperbole. So, if the Fed raises rates quickly and aggressively and combines it with selling bonds it would be equivalent to not just a pumping of the brakes, but literally, a slamming on the brakes. Of course, a massive spike in yields and rates will cause consumers to buy less. Less demand. But what effects will that have on the bigger problem: the supply side? Higher yields will not fix those logjams we have become familiar with. In fact, higher rates might even compound the problems costing manufacturers more to finance their operations. It is clear that bond buying must end, and the balance sheet must be reduced as a matter of best practices. They are no longer needed to stimulate growth. Rates must go up as well, enabling banks and bond investors to earn higher returns. Additionally, higher rates are a way for the Fed to reload its ammo stores, so they have room to lower them in the future to tackle upcoming challenges. Stimulus-driven demand will tail off at some point and supply chain disruptions will right themselves over time. The Fed can certainly cause consumers to close their wallets in the short run, but it needs to be mindful of its pace and magnitude. Sometimes, less is more. For me, I am still handwashing dishes… I am a patient man.
THE MARKETS
Stocks fell yesterday as traders responded to rising yields and a miss on the ISM Services Index. The S&P500 slipped by -0.10%, the Dow Jones Industrial Average gave up -0.47%, the Nasdaq Composite traded lower by -0.13%, the Russell 2000 gained +0.56%, and the S&P500 ESG Index dropped by -0.26%. Bonds fell and 10-year Treasury Yields added +2 basis points to 1.72%. Crypto fell by -3.57% and Bitcoin sold off by -1.11%.
NXT UP