Raging Inflation, Spiking Rates, Plunging Stocks, Oh, My!

It has been such a volatile couple of days in the markets that you hardly know where to focus.  Friday’s inflation print was 8.6% (year/year), higher than expected and the highest in forty years, showing (yet again) that the Fed’s “transitory inflation” line was always just fantasy. Despite its glacial, foot-dragging pace of response to date, the Fed will need to raise short-rates (which they directly control) faster and farther than earlier planned. The Fed does not directly control long-term rates, but they influence them by buying and selling bonds on the open markets. For years, they have been buying bonds (driving interest rates lower), but they will have to stop that and maybe go the other way, being net sellers of bonds.  This will make financing government deficits much more difficult.

Anyway, both short and long term rates have gone vertical in the past few days as markets price in all this, reaching levels not seen since the aftermath of the 2008 Global Financial Crisis:

Rates of U. S. 1-Year Bills. From Wolf Richter.

Rates of U. S. 10-Year Notes. From Wolf Richter.

https://seekingalpha.com/article/4518160-treasury-bonds-plunge-yields-spike-stock-crypto-mess

Mortgage rates will likely march even further upward, increasing the monthly payments for most homeowners. At some point, this will deflate the housing market. Some of today’s eager new homebuyers who paid over asking price, assuming that housing only goes up, may be in for a rude awakening.

It seems like the only way to tamp down inflation is old-fashioned demand destruction. Stock market participants are starting to price in the dreaded R-word (recession). The plunging stock market has been in the news the last few days. Yes, it has dropped a lot, but shown on a five-year chart below it may not be so apocalyptic. It is dropping from ridiculously over-optimistic market highs at the end of 2021.  We are still slightly above the pre-COVID peak:

S&P 500 Index. From Seeking Alpha.

If you are young and working, you should see lower prices as a buying opportunity. If you are making regular contributions to a savings plan in stocks (dollar cost averaging), your dollars are buying you more stocks. If you feel you must DO something, you could always rebalance your portfolio, shifting some funds into stocks from something else, to maintain a say 70/30 stock/bond portfolio. Peace…