The Fed Holds The Market. How Long Will It Last?

With investors discrediting fundamentals to follow the Fed’s instruction, it seems everything relies now on a few people’s say-so.

It's a Bird, It's a Plane, It's the Fed

With Jerome Powell, Chairman of the U.S. Federal Reserve (Fed), donning his cape like Superman and his monetary crew akin to The Avengers, investors’ faith in the Fed was on full display on Jun. 10. Case in point: with the headline Consumer Price Index (CPI) surging by 4.93% year-over-year (YoY) – the highest YoY percentage increase since 2008 – the bond, stock, and currency markets barely flinched.

The commodity PPI surged by 17.25% YoY in April. And if you exclude the 17.36% YoY jump in July 2008, it was the largest YoY percentage increase since December 1974. For context, the commodity PPI often leads the headline CPI and that’s why tracking the former’s movement is so important. Moreover, reconnecting with the green line implies a ~5.50% YoY percentage increase in the headline CPI.

Please see below:

And with the indicator proving quite prescient once again, the gap on the right side of the chart was nearly filled on Jun. 10.

Furthermore, while investors continue to see the world through the Fed’s X-Ray Vision, “base effects” are now the primary defense among the superhero’s supporters. However, as I’ve mentioned on several occasions, it’s important to remember that the core CPI increased by 0.74% month-over-month (MoM). And if you exclude April’s rise of 0.92% (which was only one month ago), it was the highest MoM percentage increase since 1982.

Please see below:

The Fed Has Become Independent Thought’s Kryptonite

On top of that, with the YoY percentage change in the headline CPI running extremely hot, the real Federal funds rate is now at its second-lowest level ever. For context, the Federal funds rate is the overnight lending rate set by the FOMC, while the real Federal funds rate is adjusted for inflation by subtracting the YoY percentage change in the headline CPI.

Please see below:

So how can we explain investors’ lack of prudence?

Well, as Bloomberg eloquently put it on Jun. 10…

Source: Bloomberg

Thus, with the Fed mesmerizing investors and keeping them under its spell, market participants have determined that it’s easier to follow the Fed rather than fight it. However, when screaming fundamentals are dismissed as irrelevant, it often ends badly for those who fail to heed the warnings. To that point, while the Producer Price Index (PPI) – which will be released on Jun. 15 – will provide important clues on the inflationary trajectory, Nordea’s trend model signals that YoY CPI prints still have plenty of room to run.

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Disclaimer: All essays, research and information found on the Website represent the analyses and opinions of Mr. Radomski and Sunshine Profits' associates only. As such, it may prove wrong ...

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