Is A Decline In Inflation Enough To Halt The Rise Of Interest Rates
There Are Many Factors In Play
The primary driver of the rise of interest rates from 5000-year lows has undoubtedly been the inflationary pressures produced by COVID-induced supply chain disruptions, which have more recently been exacerbated by the Russian invasion of Ukraine and its effect on energy and grain prices.
The accompanying chart below illustrates that central banks’ efforts to tame supply-side derived inflationary pressures using the traditional tool of combating demand-derived inflation (interest rate increases) has thus far proven ineffective.
We have written that supply-driven inflation will only abate significantly when the supply disruptions begin to ease. There is evidence that the COVID-induced issues are calming while energy and grain prices are currently well off their peak prices.
Inflation may have peaked (at least temporarily), so should we expect a halt in the Fed’s rate increases after July?
There is a reasonable probability that rates will continue to rise in the near term. We believe that the Fed (and other central banks) see the resurgence of inflation as an opportunity to attempt to restore interest rates closer to historical norms. Doing so would address some of the economic distortions produced by the recent era of ultra-low interest rates and restore a tool to central banks to address future recessions (interest rate reductions).
We believe that central banks are more apt to aggressively increase rates toward historic norms until there is clear evidence of recession. That is why we think a global recession is unavoidable (among other reasons).
Of course, other factors may play a role in supplying new fuel for inflation, such as the emergence of a dangerous new COVID variant or a halt of Russian energy exports to Europe which would produce a spike in global energy prices.
The number of available catalysts for market volatility is alarming, which makes economic assumptions difficult to make. The current influence of inflation on rates is one example, as are assumptions related to the end of the current bear market.
We see a good deal of volatility in the months and years ahead that will produce both significant risk and great opportunities.
Each month in the Global Investment Letter, I update my investing activities, as well as comment on major global equity, fixed income, currency, and commodity markets.
If you found this post of interest, you’ll find the Global Investment Letter of value. To view free sample issues of our paid service and to receive our free weekly investment comment please visit: https://www.globalinvestmentletter.com/sample-issue/
