Hi All

Thank goodness the Winter solstice is behind us. Days will steadily get longer and nights shorter. Soon Spring will be here again. In the meantime volatility abounds on markets everywhere. Traders and investors are desperately trying to price in inflation which they haven’t had to contend with for decades.

In fact the central assumption is that the current strong uptick in US inflation is transitory and will ease again soon. But late last week the Fed (US Federal Reserve) gave an update intimating that they are starting to see inflation as permanent and anticipate interest rate hikes to be sooner and higher than the market is expecting. They also indicated they would start reducing (tapering) their bond buying program sooner than expected. In short these may mean the end of “easy money”.

As previously mentioned these signals have been coming for a while already but haven’t necessarily been taken seriously enough. There are mitigating factors for this, one being this wouldn’t be the first time in the last 10 years that inflation fears proved to be unfounded. So traders could be forgiven for getting it wrong. But despite the time-proven saying that the most expensive words in investing are “this time is different”, it appears this time could well be different.

For the first time in a long while the US economy is running at just about full throttle. Inventories are still too low to fulfil demand, there are crippling shortages in supply due to many years of underinvestment in productive capacity and commodity prices have spiked due to supply/demand dynamics. Even finding the right employee is no longer simple and in some sectors candidates are paid to go for interviews! Pressures are building and the outlets which have worked in the past 10 years or more no longer automatically apply.

The Fed is out of levers to pull in artificially keeping interest rates low and must now face the music, something they have studiously managed to avoid since the GFC. In fact the whole thing started in the mid-1990s with a guy many have forgotten or never even heard of, the then Fed Chairman Alan Greenspan. He showed that money could ignominiously be printed without immediately creating inflation, which subsequently became standard practice in the US every time they needed to revive their economy. Other governments saw this and followed suit. Now the world is awash with cash which wasn’t efficiently employed, has found its way into asset prices and may be coming home to roost. Economics 101 says you can’t print that kind of money out of thin air without inflation.

Last week there were significant reversals on virtually all stock exchanges, bond yields increased and the US$ got stronger, weakening Emerging Market currencies in particular. Perhaps it was a kneejerk reaction and one won’t be surprised to see some or all of this reverse in the coming trading days and weeks, but be sure the volatility will continue until there is clarity on the issue.

More next time.

Kind regards,

Ricky Williams
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