We’re getting good at defying gravity. The U.S. stock markets, across the board, are at or near their all-time highs. The U.S. dollar remains strong relative to the euro, yen, loonie, and pound. In an effort to help avoid a U.S. recession, the Federal Reserve dovishly cut the Fed Funds interest rate by ½ of a percent on September 18th.
This new easing action triggered other interest rates to fall and bond price to rise (as bond prices and rates move inversely). Precious metals continued their nearing 30% ascent YTD. The soaring price of coffee (close to 40% higher YTD) has made it a lucrative target for criminals to snatch unharvested beans under the cover of darkness straight from trees in Uganda. While, most other agricultural and energy commodities have seen significant price drops, that have helped to stabilize inflation in general.
Higher inflation makes everything more difficult. As an example, a decline in borrowing costs could fuel mortgage loan demand, renewing a buying frenzy within the inventory constrained for-sale housing market (i.e., home price appreciation is likely to continue to accelerate as U.S. house prices are pproximately 55% higher compared to the February 2020 pre-pandemic level, reducing affordability for first-time home buyers). A second potential apple to fall could be slowing sales, as struggling consumers (i.e., with shrinking real income) cut back on their spending. A third apple could be rising job losses. The Business Roundtable reported CEO’s have moderated their hiring plans two quarters in a row.
A rising unemployment rate (from its current 4.2% level) would exacerbate concerns of a stalling economy. And a fourth potential apple heightening concerns that the U.S. economy is slowing could be declines in industrial production. If those apples fall from the tree, gravity’s effects would certainly be felt.
The equity markets seemingly will continue to defy gravity. But, to paraphrase another of Newton’s quotes, gravity is essential and inherent to matter…but the cause of gravity is what we do not pretend to know.
So…what could possibly go wrong when gravity is involved? To quote Sir Issac Newton who discovered gravity, “every action has an equal and opposite reaction.” What could gravity pull off the apple tree? The first apple will likely be…even higher inflation! With the Federal Reserve expected to cut short-term interest rates further by 1.50%, there becomes an increasing chance that the U.S. dollar depreciates, real borrowing costs drop, and a reasonable expectation that various equity markets could inflate from here. Unfortunately, asset inflation often leads to rising consumer inflation. Furthermore, a rising stock market is not the same thing as economic growth.
Source: Bloomberg LP. Content should not be regarded as a complete analysis of the subjects discussed. All expressions of opinion reflect the judgment of the author as of the date of publication and are subject to change. Material presented is believed to be from reliable sources, however, we make no representations as to its accuracy or completeness. This document does not constitute advice or a recommendation or offer to sell or a solicitation to deal in any security or financial product.
