Inflation Causing Havoc On World Economy; Bulls ‘Nowhere To Be Seen’

Inflation is either at double digits, or near double digits, worldwide. Only China has low inflation, coming in at around 3% year-over-year, but who believes them? Their currency is now trading at a two year low against the dollar and food prices are up over 6%. Americans and Europeans haven’t seen inflation like this since the 1970s. The U.S. inflation readout rose a tad on Tuesday, but showed food prices still stubbornly high even as gasoline prices declined.

Economists from major investment banks and the International Monetary Fund have lowered their global growth outlook. Despite yesterday’s big drop in the Dow, it is still not in bear market territory. A bear market is defined as a 20% decline from the high point reached that year. The Dow is down maybe 14% year-to-date and only 10% in the last 12 months. Investors have been moderately bullish all summer long, hoping interest rate hikes would stop. The summer is coming to an end.

For now, the U.S. is still the best of the worst, Goldman Sachs said in a note to clients this week, calling Europe’s economy “dire”. FTSE Europe is definitely in a bear market. If you’re a European fund manager, guess where you put your money? Hint: not in Germany industrials or Eurobonds.

Money managers yanked $3.4 billion from European stock funds in the week ending September 7, taking total outflows in the past six months to $83 billion, according to EPFR Global, a fund tracker based out of Cambridge, Mass.

“We expect a deeper, prolonged recession (in Europe) and more persistent elevated inflation due to the impact of higher energy prices,” Barclays Capital economists led by Silvia Ardagna wrote in a note to clients on September 14. This is the second time in five days that they called a deep recession in the EU.

Inflation: Where We’re At

Tuesday’s consumer price index rose 8.3% year-over-year, below the 8.5% reported in July and above 8.1% consensus estimates. Excluding food and energy, inflation rose to 6.3% year-over-year from 5.9% in July. On a monthly basis, inflation rose 0.6% compared with 0.3% in July. This was the reason for yesterday’s sell-off and Wednesday’s tepid 0.5% gain in the morning hours.

Expectations for even further rate hikes from the Federal Reserve drove the yield on the 2-year Treasury up 17 basis points to 3.74%, while the 10-year yield was up 5bps to 3.41%. That is around 200 basis points above anything bond investors will get in Europe, so expect more inflows into the dollar going forward. The Dollar Index rebounded 1.4%, and Brent crude fell 0.8% to $93.17 as demand is seen deteriorating as the recession heats up.

At a sector level, while all S&P 500 sectors are in trouble, the rise in interest rates weighed on growth stocks in particular.

“The equity rally over the past week was based more on sentiment than a material change in the underlying economic drivers,” says Mark Haefele, chief investment officer for UBS Global Wealth Management. “Tuesday’s selloff is a reminder that a sustained rally is likely to require clear evidence that inflation is on a downward trend.”

It’s not.

In the UK, however, where the cost-of-living crisis has become a major headache for policymakers, CPI numbers brought some good news on Wednesday as the headline inflation has eased off but is still running five times higher than the Bank of England’s (BOE) target.

Core inflation there is still trending upwards. This means that the BOE, like the Fed, like the European Central Bank, still has to raise rates further or give up on its mandate to fight inflation.

Prices Up Everywhere (But At Least We’re Not These Guys)

The Western powers, led by the U.S. and European Union, have high inflation. But it is low compared to these emerging market countries (as of July/August):

Turkey: 80.21%

Argentina: 71%

Pakistan: 25%

Nigeria: 20%

Russia: 15.1%

Of the BRICS, Brazil, India, South Africa and China all have lower inflation than the U.S. and Europe. When has that ever happened?

Meanwhile, back at the ranch, many members of the U.S. Federal Reserve say they want to increase interest rates more aggressively to knock out inflation once and for all. Fed Chairman Jerome Powell has been reluctant to do so, as higher rates hurt economic growth and will ruin all margin trades out there, of which hundreds of billions of dollars are on the line.

Retail investors need to stay away from margin. Those with margin accounts on E*Trade and other platforms would be wise to close them and save their ammo for when the odds are better. High inflation is a margin investors’ worse nightmare.

“Powell will struggle to make his case to slow the pace of rate hikes,” says Naeem Aslam, chief market strategist for AvaTrade in London. “He will have very little to say in his defense. This is what is worrying me the most. Bulls are nowhere to be seen in this market.”