Inflation

Posted By Darren Winters on Mar 26, 2021


Inflation

Inflation expectations which caused recent turbulence in the treasury bond market with rising yields are starting to spill over into stocks, particularly growth stocks that rely on cheap credit to fund expansion. 

The inflation tremor is already being felt the most in Nasdaq stocks

These are the growing technology, software, biotech, fintech, EV related stocks. So, a Nasdaq sell-off played out yesterday, 24 March with the technology weighted index down 2.1% pulling all other major indices in the red. The recent sell-off is no big deal, bearing in mind the Nasdaq is up 74% one year to date and down only 4.86% over the month. 

Could rising inflation along with rising Treasury yields trigger the end of the longest secular bull market in stocks and bonds?

Inflation

In other words, will inflation prick the everything bubble? The unregulated cryptocurrency, a market-driven by the hype that constantly needs a fresh flow of money from new buyers to keep prices inflated, similar to a Ponzi scheme, could also be in the latter phase of the tulip mania. A stock market correction or even crash could trigger massive margin calls, bearing in mind that investors are highly leveraged since borrowing costs are so low. 

Ray Dalio recently recommended investors borrow money and invest in assets with more than a zero return. “Cash is trash” said Dalio. 

If inflation is the catalyst for the next stock market crash, then investors could end up selling everything to raise liquidity to meet margin calls

So, the hype driving Bitcoin up could be violently reversed. In such a scenario when liquidity is tight, discounts are abundant and cash is king. 

Why should investors be worried about inflation when Fed chair Powell surrounded by an army of Ph.D. economists doesn’t appear to be worried about inflation

“You can only go out to dinner once per night,” said Fed chair Powell. So, service sector demand in the post-pandemic economy is anticipated to normalize swiftly. 

Put another way, the Fed thinks transient inflation caused by pent-up demand for services is no big deal.

But it is not demand-pull inflation that investors are worried about it is the monetary inflation type that investors are fretting over. 

The Fed has said it wants to make “substantial further progress” on its twin goals of maximum employment and stable 2% inflation. Fed chair Powell referred to the 465,000 jobs created in the private sector in February as “a nice pick-up,” then added, “you can go so much higher, though”.

Could the Fed be adopting a “stop-go” monetary policy, which alternates between fighting high unemployment and high inflation? 

During the “go” periods, the Fed lowered interest rates to loosen the money supply and target lower unemployment. 

If a “stop-go” monetary policy is what comes next then a stock market crash is unlikely, but the bull market in stocks could have a bit more volatility than usual when the Fed lets yields rise, tightens the money supply, thereby keeping monetary inflation under control. 

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