Rising Rates Just One Equity Market Risk Creating Broad Bearish Uncertainty

 | Jun 21, 2022 17:17

  • May CPI was ugly, PPI not much better
  • Fed hikes but remains far behind inflationary curve
  • Stocks not plunging; but eroding
  • VIX edges higher without spiking
  • Rising rates only small part of bearish problem

    • Stocks have had a rough time in 2022, with the NASDAQ Composite, S&P 500 and Dow Jones Industrial Average posting substantial losses since Dec. 31.

    After years of low interest rates and inflation below the Federal Reserve’s 2% target, consumer and other prices have soared. The Fed and U.S. Treasury called increasing inflation a “transitory” event throughout most of 2021, blaming rising prices on pandemic-triggered supply-chain bottlenecks. While policymakers have now acknowledged they were wrong, the central bank and government officials have not taken responsibility for inflation.

    In 2020, artificially low interest rates and quantitative easing created a liquidity tidal wave. Government policies to stimulate the economy during the pandemic were unprecedented. While necessary, the policies were haphazard, lasted far too long, and planted inflationary seeds that sprouted during the second half of 2020, bloomed in 2021, and spread like wildfire in 2022.

    Rising CPI and PPI data and a declining bond market sent warning signals. The first major war in Europe since the Second World War and a bifurcation between nuclear powers only exacerbate inflationary pressures.

    Stocks rallied while interest rates were low, but the markets now face a landscape where rates will chase inflation on the upside. Capital is flowing from equities to fixed-income investments, and the prospects for the stock market look ugly in June 2022.

    h2 May CPI Was Ugly, PPI Not Much Better/h2

    The May U.S. Consumer Price Index came in hot as a pistol, with the highest reading since December 1981. The CPI rose 8.6% from the previous year, with the core reading up 6%. Both were higher than the market had expected. The Producer Price Index rose 10.8%, continuing the streak of double-digit increases.

    Surging food, gas, and energy prices underpinned inflation as they filter through to the core reading, impacting prices of all goods and services. Rising inflation has been a call to action for the world’s central banks. The European Central Bank recently said it would lift interest rates out of negative territory, but inflation will continue to cause real interest rates to remain below zero as inflation erodes the euro’s value. The same goes for the U.S. central bank, which began increasing rates and tightening monetary policy before the ECB.

    h2 Fed Hikes But Remains Far Behind Inflationary Curve/h2
    Get The App
    Join the millions of people who stay on top of global financial markets with Investing.com.
    Download Now

    On Wednesday, June 15, the Federal Reserve increased the short-term Fed Funds Rate by 75 basis points to a range of 1.50% to 1.75%. The central bank had not boosted the rate by three-quarters of a percent since 1994. The Fed considers the core CPI reading the most reliable inflation data because food and energy prices are highly volatile. At a core reading of 6%, the bottom end of the Fed Funds band is one-quarter of the Fed’s favorite inflation metric.

    The core measure could be a mirage in the current environment because of the significant increases in food and energy prices due to the war in Ukraine that has changed the nature of these markets. The war creates a supply-side problem for the economy. The central bank’s tools tend to be effective on demand-side economic dynamics.

    The bottom line is that at a 1.50%-1.75% short-term interest rate, the central bank is far behind the inflationary curve, which can only exacerbate the economic condition.

    h2 Stocks Not Plunging, Rather Eroding/h2

    The leading stock market indices have made lower highs and lower lows in 2022. The downside pressure began to intensify in mid-June.