Inflation fear just won’t go away

Stocks ended another day underwater as investors braced for the potential for more bad news ahead of earnings and a key inflation indicator later this week. A new chapter in the US-China trade war begins with semiconductor restrictions – chip stocks take it on the chin.

Destructive nature. Hey Ben, someone with a heavy Swedish accent is on the phone for you, he said something about a prize; should I take a message? Do you remember Ben Bernanke? Come on, you remember. Think back to the last time you had so much stress about the economy and the stock market. No, not the COVID crisis, the time before that. Ah, now you remember, The Global Financial Crisis combined with The Great Recession. If you weren’t of investing age during those, I can assure you that they were tough, as indicated by those events have a “the” with a capital “T” in front of them.

Ben Bernanke was the Fed Chair during the 2008 recession. He was appointed in 2006 by George W. Bush. He followed in the footsteps of the venerable Alan Greenspan during a time of great expansion. Inflation was at a somewhat elevated 4-ish percent, and the stock market was rallying. Yields were between 4.5% and 5% for the 10-year AND the 2-year Treasury Notes. That’s right, the yield curve was flat and moving in and out of the negative/inverted zone. What was Bernanke’s Fed up to in those days? Why, they were raising the Fed Funds rate, of course. His Fed would raise the Funds rate 4 times capping out at 5.25%, before pausing late in the year. By September of 2007, consumer confidence was waning, and the housing market was struggling after a boom which peaked as Bernanke took office. The Fed switched gears and began to lower interest rates. Three successive rate cuts in late 2007 were simply not enough to keep the US economy from falling into a recession. The mortgage market imploded leading to the collapse of Lehman Brothers and Bear Stearns in 2008 compounding economic hardship and causing stocks to sell off. The Fed would cut rates 7 times in 2008 ending up just above 0% for the first time… EVER. ZIRP, or Zero Interest Rate Policy, in the US was born. Japan really invented it in the 1990s. The collapse of the banking system due to the sub-prime mortgage crisis made even ZIRP less effective at stimulating the economy. Something new had to be deployed and quantitative easing, or QE, was born. I won’t bore you with the rest of the details, but the economy recovered by mid-2009 and stocks began their epic, but not always straight-up journey back up and ultimately on to make new high after new high. The end. Bernanke melted into history when Janet Yellen took over the reins at the Fed in 2014. She had the tough job of having to engineer the reversal of the post-recession easy money period. Rates wouldn’t actually take off until late 2015. Jerome Powell took over in 2018 just in time for a dovish pivot and ultimately back to ZIRP and QE during the COVID pandemic. A lot has happened since Bernanke rode into the sunset, so it is understandable if you forgot about him.

The Royal Swedish Academy of Sciences didn’t forget him however, and it awarded him the Nobel Prize in Economics for his “groundbreaking research on banks and financial crises.” Interestingly that research was conducted in the 1980s and ultimately informed his decisions during the 2008 crisis. Good on you, Ben! Unfortunately, Mr. Bernanke cannot just sit back and sip champagne with his colleagues (he shared the prize with 2 others) because, if you hadn’t noticed, the global economy is once again in crisis mode. The Nobel prize, aside from the cool medal, comes with a 10 million Swedish kronor cash award. While that seems like a handsome sum, it was… er, quite a bit handsomer earlier this year. It would have been worth around $1.1 million in January, but only $883 thousand today… and shrinking. The reason is the strong US Dollar which has been strengthening along with tougher Fed policy and higher bond yields. Companies are facing a similar situation when they have to convert their foreign earnings back into US currency. The strong US dollar is also responsible for making US dollar denominated products more expensive for foreign buyers, and more expensive ultimately leads to lower demand and earnings for US companies who sell abroad. The stronger dollar simply adds to the already-inflationary environment, making it yet more taxing on foreign buyers. At some point, we know that buyers will simply buy less or stop buying products altogether. This is referred to as demand destruction, and it is, technically what the Fed is hoping for. Cargill, a private US company that produces crops amongst other things announced that it expected demand for mainstays like corn, soy, and wheat to drop off in coming months as a result of inflation and dollar strength. Similar admissions are expected in coming weeks from other companies as they make their Q3 earnings announcements.

Today’s Fed, which faces similar challenges to those faced by Bernanke in 2006/2007, is hard at work trying to slow down the economy, and hints of its success (if you can call it that) are beginning to form. Fear not, because the Fed will, at some point, find itself in a situation in which it must, once again, consider not only halting the rate hikes, but lowering them. Bernanke, knowing that rates are going higher before they go lower is already likely to have converted his prize into US dollars. Congratulations, Ben.

YESTERDAY’S MARKETS

The markets, unlike Ben Bernanke, did not celebrate yesterday as stocks traded lower on continued Fed inflation and rate hike fears. The S&P500 fell by -0.75%, the Dow Jones Industrial Average slipped by -0.32%, the Nasdaq Composite Index dropped by -1.04%, and the Russell 2000 Index declined by -0.60%. The bond market was on holiday yesterday and yields are slightly higher this morning as trading resumes. Cryptos slid by -1.25% and Bitcoin was down -1.25%.

NEXT UP

• NFIB Small Business Optimism (Sept) came in at a higher than expected 92.1 after coming in at 91.8 last month.
• Cleveland Fed President Loretta Mester will speak today.