Trail 16 — Inflation, QT & Risk assets

Jan 14 2022 (Editor — Sylvia Lo)

Inflation

U.S. inflation has risen the fastest in four decades. According to Labour data released on Wednesday, the consumer price index climbed 7% in 2021, the most significant 12-month gain since June 1982. The widely followed inflation gauge rose a further 0.5% in December.

Federal Reserve Chair Jerome Powell has said the central bank would prevent higher inflation from becoming entrenched. As we continue to ride out this pandemic, he cautioned that economic recovery would look different from the previous expansions. This has led the Markets to price in rate hikes in 2022 aggressively.

Quantitative tightening

According to Goldman Sachs Group Inc, the Fed is expected to raise interest rates four times this year, with balance sheet runoffs commencing around July. As more inflation data rolls in, what was once seen as radical estimates around rate hikes is now practically conservative. A few weeks ago, predicting that the Fed would raise rates four times in 2022 would have been considered highly improbable. Currently, not only has it been priced in, but JPMorgan Chase & Co. CEO Jamie Dimon is saying the U.S. economy can handle even more. With jobless rates now below 4%, coupled with wage increases, Jamie Dimon has said that, for the first time in his life, there’s “huge pressure” on the U.S. labour market. “The price of labour’s going up, and we’re going to have to deal with it,” he said in an interview on Fox Business that aired Tuesday.

As central banks worldwide begin to tighten their money supply, there is a growing reliance on the private sector to absorb a more significant portion of debt in 2022. As central banks drop $2 trillion in net demand, this adds upward pressure on yields to rise further and will provide a real-world test of how much private demand exists.

With inflation driving most policymakers to tighten settings, investors will need to absorb around $230 billion of the estimated money supply.

Risk assets

Many economists and fund managers, including the famous Michael burry, have been touting a market correction for some time. With Government debt yields rising, there has been some rotation from Growth assets (Tech stocks) to Value assets (Banks). Bank of America strategists has reported that bubbles are “simultaneously popping” in areas including cryptocurrencies, palladium, long-duration technology stocks, and other historically risky pockets of the Market. Now, with the winding down in speculative areas, investors have been quick to act as they brace for the U.S. Federal Reserve to pick up the pace of policy tightening.

Editor’s corner

A.I. can now detect new covid “variants of concern.”

In other news, BioNTech, the German company that pioneered the messenger RNA technology used in the Pfizer vaccine, has partnered with InstaDeep, a London A.I company, to create an ‘early warning system’ for new coronavirus strains.

These two companies were able to pick up 12 of the 13 variants designated as “variants of concern” almost two months before the World Health Organisation released an official statement. “More than 10,000 novel variant sequences are discovered every week, and human experts simply cannot cope with complex data at this scale,” said Karim Beguir, the co-founder and chief executive of InstaDeep. We all knew A.I would take over eventually, and in this instance, it has provided some much-needed light as we fumble our way through this covid tunnel.

Environmental issues set to take centre stage

A recent survey conducted by EY provides insight into the priorities of U.S. CEOs in 2022: a whopping 25% of those pursuing M&A activities say they plan to increase their ESG performance or improve their sustainability footprint. With most CEOs adopting ESG for strategic reasons — such as creating a competitive advantage or lowering their capital cost, naysayers are moving away from the notion that this trend is about “greenwashing” or pressures from the regulator.

Until next week.

Financial markets are fascinating, and I see them amalgamating the subjective and objective worlds. They are constantly evolving, follow no predetermined path and much like humans and society in general, their behaviour at most times is irrational. Yet, their day to day functioning is seemingly driven by facts and reasoning. They are filled with plenty of stories of triumph, tragedy and comedy. Every day they are thoroughly analysed and tried to make sense of. Yet, their future steps or directions cannot be predicted based on history. They follow a random walk. Therein lies their beauty.

If enjoying making sense of their randomness is as appealing to you as it is to me, each week, I briefly recap a few stories that captured my interest, with embedded source links available for those who wish to read more.