This morning at 8:30 am Eastern Time, the Bureau of Labor Statistics revealed the latest figures for a key measure of inflation in the United States. The Producer Price Index (PPI), which tracks changes in the prices of goods and services sold by producers, was expected to increase by 0.4% month-over-month in October; instead, it only rose by a mild 0.2%. Likewise, Core PPI (which excludes volatile food and energy prices), was forecast to increase by 0.3% month-over-month, but remained static, changing exactly 0% instead. These surprising PPI numbers today offer yet another instance of American inflation dropping following the recent low CPI report, building a bearish case for USD and a bullish one for stock market indices as the need for a hawkish Fed ostensibly lessens. However, I am personally skeptical of this development as many underlying economic fundamentals have not changed, as we will discuss below.
Markets to Watch
My bias remains bullish on USD, and bearish on the US stock market, for three primary reasons: A) None of the crises the world is contending with have evaporated: an energy crisis still looms with winter around the corner, and many markets are still hot with artificial demand following quantitative easing mid-pandemic. B) The Democratic Party in the US, which tends to be seen as a pro-stimulus party, recently outperformed expectations in last week’s midterm elections, which I predicted could create short-term rallies in the stock market (but longer-term bullishness for USD). C) One month’s worth of data on inflation is not enough to mark a trend; October’s low numbers could easily be outliers, perhaps due to tapping into oil reserves to alleviate cost-of-living increases.
For those who remain bullish on USD and anticipate the Fed further hiking interest rates at a historic pace to quell high inflation, the following markets will be key to watch. They are listed below with their respective EdgeFinder ratings, signals/biases (which diverge from mine), and corresponding charts.
1) EUR/USD (Receives a -2, or ‘Neutral’ Signal)
2) US30 (Receives a 4, or ‘Buy’ Signal)
3) USO (Receives a -5, or ‘Sell’ Signal)
This week has been fascinating for financial markets: stock markets have performed quite well despite global interest rate hikes and some disappointing tech earnings in the US, while the US Dollar Index continued to decline from late September’s highs. These movements are perhaps only more surprising considering that key data on the US economy was released both yesterday and today, and the chances of it further emboldening the Fed are plausible. With the Federal Reserve scheduled to adjust the Federal Funds Rate (a key interest rate in the US) on Wednesday next week, and full-blown recession still looming in the minds of investors, it is worth unpacking this fresh data in order to ask: what will the Fed do?
Consideration #1: Surprising GDP Growth
Yesterday morning at 8:30 am Eastern Time, the US Bureau of Economic Analysis released some shocking information. Quarter-over-quarter Gross Domestic Product (GDP) in the US, a measure of economic output, was estimated to have grown by a whopping 2.6% from July through September, even more impressive than the 2.3% which had been forecasted. This is a welcome respite for a country that had just met the criteria for a technical recession (two consecutive quarters of negative GDP growth). However, this remarkably positive growth may leave the Federal Reserve only feeling more at peace with their monetary tightening regiment, since GDP contractions may have kept them somewhat cautious about the severity of their rate hikes.
Consideration #2: High Core PCE Index
This morning at 8:30 am ET, the Bureau of Economic Analysis also released new inflation data. The month-over-month Core Personal Consumption Expenditures (PCE) Index, which measures the cost of goods and services purchased by consumers (excluding volatile food and energy prices), rose by 0.5%, perfectly meeting market expectations. While not bullish in the sense of exceeding forecasts, context is crucial: not only are these figures high, but they are also identical to last month’s increase. Considering that the Core PCE Index is the Fed’s preferred measure of inflation, it seems likely that the FOMC, the Fed’s policy-making committee, could interpret these numbers as an indication that recent rate hikes have been insufficient for quelling inflation.
Consideration #3: High Personal Spending
The Bureau of Economic Analysis also reported higher than expected personal spending this morning, clocking in at 0.6% month-over-month, much higher than the 0.4% forecast. Though not holding the same significance as other indicators and measures of inflation, this increase marks a pattern, with personal spending similarly beating market expectations with a 0.6% increase the previous month. Considering that the intention behind the Fed’s interest rate hikes is to curb consumer demand by limiting borrowing and spending, hot personal spending numbers help indicate that their goals have yet to be realized.
Likelihood of Fed Decisions
In light of these latest developments in economic fundamentals, the odds of continued Fed hawkishness seem only more likely. Between a return to positive economic growth, persistently high changes in core prices, and historically hot labor markets and consumer spending, a 75 basis point rate hike seems all but certain next week. A full 100 basis point hike, while not currently forecasted, may not be off the table either, though they may refrain due to concerns about inflation data as lagging indicators (rendering current data somewhat unreliable for exhaustive Fed decision-making).
Conversely, some analysts are predicting the Fed easing up on their contractionary monetary policy aggression soon. The Employment Cost Index (ECI), administered by the US Department of Labor, revealed that wages in the private sector grew by 1.2% in Q3; though still remarkable, it is a decline from the 1.6% increase in the previous quarter. While these slower increases in pay could theoretically bring core inflation a bit lower soon, these numbers are still incredibly hot. Considering that the Fed has made it clear that they are willing to err on the side of hawkishness for the sake of returning annual inflation to 2% (down from the current rate of 8.2%), the notion that a Fed pivot towards smaller hikes will be coming soon seems rather premature.
Personally, I am anticipating further bouts of Fed hawkishness, and a corresponding return to bullish momentum for USD across major pairs. Likewise, I am expecting that the bear market for equities is not over, and that the recent rally will only make the Fed more comfortable indulging in rate hikes. Regardless, this coming Wednesday’s FOMC Statement and press conference will keep us updated on the Fed’s vision for the near future. The Statement and rate hike will be made known at 2 pm ET on Wednesday, November 2nd, with the press conference immediately to follow. The EdgeFinder, A1 Trading's market scanner which aids traders by providing supplemental analysis, is currently bullish on both USD and the S&P 500.
At 8:30 am ET this morning, the United States Bureau of Labor Statistics released a new set of shocking Consumer Price Index (CPI; a proxy for inflation) data. Month-over-month CPI and Core CPI (which excludes volatile food and energy prices) both rose far more sharply than expected in September. Month-over-month inflation had been forecast to rise at 0.2%; instead, it jumped by twice that at 0.4%, equating to 8.2% year-over-year. Likewise, core inflation was anticipated to hit 0.4% month-over-month, instead rising by a staggering 0.6%. Though today’s market activity did not reflect as such, this is incredibly bullish news for USD, as it further validates the Federal Reserve’s hawkish agenda, paving the way for more rate hikes. Let’s discuss what today's CPI news means, and several potential options for trading it.
Second Wind for Stocks?
The Dow Jones Industrial Average soared over 800 points today, or nearly 3%, on the inflation news. There is a chance this could be a bit of a reflexive fluke on the part of institutional traders (due to annual inflation technically decreasing from 8.3%), because current market conditions in the US remain holistically bearish for equities as the Fed slows economic output. However, there is also a possibility that the CPI news made stock traders more optimistic in the short term; after all, the Fed’s continued rate hikes were already all but certain, but consumer spending has evidently remained resilient despite monetary tightening. Thus, it could be the case that we see a stock market rally on a stronger-than-expected economy, however brief it may be.
Even More USD Strength
Similar to a jump scare in a horror movie revealing that the monster isn’t truly dead at the end, high inflation has once again reared its ugly head. The Federal Reserve will almost certainly feel ever more emboldened in their efforts to slow the economy, perhaps now further into the future as well, since Fed Chair Powell has made it clear he wants to err on the side of caution due to lagging indicators. Because USD has primarily surged in value in conjunction with the Fed’s interest rate aggression, it seems likely that demand for the US Dollar will yet again continue en masse.
Four Pairs to Trade
Here are four of the best forex pairs to keep an eye on for USD bulls, according to the EdgeFinder, A1 Trading’s handy market scanner. They are listed below with their respective ratings, signals/biases, and corresponding charts. The US Dollar's strange drop in value today may make for some optimal points of entry for those planning to go long on USD.
1) EUR/USD (Earns a -6, or ‘Strong Sell’ Signal)
2) XAU/USD (Earns a -6, or ‘Strong Sell’ Signal)
3) GBP/USD (Earns a -5, or ‘Sell’ Signal)
4) USD/JPY (Earns a 4, or ‘Buy’ Signal)
Tomorrow morning at 8:30 am Eastern Time, the United States Bureau of Labor Statistics will release three key monthly labor data reports: Average Hourly Earnings (month-over-month), Non-Farm Employment Change/Payrolls (NFP), and the new US unemployment rate. These three measures of nationwide labor market activity, and NFP in particular, have tremendous market-moving potential as fundamental catalysts. This likelihood of volatility across financial markets warrants a warning: NFP is nearly here.
Currently, markets are forecasting an 0.3% increase in average hourly earnings in September (which equates to higher costs for businesses and more money for employees), 248,000 new non-farm payrolls added to the US economy, and an unemployment rate of 3.7%, unchanged from August. If the real numbers exceed these expectations on Friday, this will likely be bullish news for the US Dollar, since the Fed will have further incentive to raise rates to cool the economy. However, if the real numbers fail to meet these expectations, this may be interpreted as bearish for USD, since it could prompt the Fed to consider pumping the brakes on further interest rate hikes. If Wednesday's NFP estimates are any indication, a hotter-than-expected US labor market seems plausible, which would benefit USD bulls.
Two Potential Pairs to Buy
The following pairs are rated favorably by the A1 EdgeFinder as potential buying opportunities for those aiming to go long on USD. They are listed below with their respective ratings and signals, along with their EdgeFinder analysis and current trends on a 1-day timeframe.
1) USD/JPY (Earns a 4, or ‘Buy’ Signal)
2) USD/CHF (Earns a 4, or ‘Buy’ Signal)
Two Potential Pairs to Sell
The following pairs are rated favorably by the A1 EdgeFinder as potential selling opportunities for those who are bullish on USD. They are listed below with their respective ratings and signals, along with their EdgeFinder analysis and current trends on a 1-day timeframe.
1) EUR/USD (Earns a -7, or ‘Strong Sell’ Signal)
2) GBP/USD (Earns a -5, or ‘Sell’ Signal)
Last week’s selloff was brutal for investors in the US stock market: the Dow Jones Industrial Average closed at its lowest level since late 2020, falling to 29590.41, losing 1.6% on Friday alone. With the S&P 500 currently down a whopping 23% from January’s highs this year, and other indexes close behind percentagewise, stock market bulls are understandably desperate to find any event to warrant optimism. Unfortunately, despite some respite from US inflation in July and August, there does not appear to be much reason to expect this selloff to stop anytime soon. With bearish momentum emerging for equities, and fears about an impending crash and recession growing, we have no choice but to get ready for the bear market.
What is a Bear Market?
Technically speaking, there is no strict definition for a bear market, since it is a more colloquial term than an exact set of financial conditions. However, it is generally agreed upon that when analysts refer to a bear market, they are discussing a financial market or index that has lost at least 20% of its value from recent highs. It is also worth noting that a bear market can occur without that market crashing, since a crash often refers to a dire situation in which said market loses at least 10% of its value in a single day.
Why is This Happening?
Many factors can contribute to a bear market, ranging from trade and foreign policy issues, to market-generated financial crises, to fiscal and monetary policy. In this particular situation, there appear to be two interrelated key catalysts creating a looming bear market in the United States:
1) An extremely hawkish Federal Reserve that is in eager pursuit of contractionary monetary policy, with economic growth being sacrificed accordingly. Chair Powell recently emphasized this at the FOMC press conference by explaining that for now, the Fed can only fulfill its ‘dual mandate’ by focusing on stabilizing prices at the expense of high employment, for the sake of eventual maximum employment. Stocks are not just a casualty in the effort to reduce high prices, they are a primary target.
2) Poor economic forecasts for both businesses and consumers, tied together in a vicious cycle. High interest rates will make it difficult for businesses to borrow or attract investors, as their high-risk shares and bonds will be far less lucrative compared to low-risk alternative securities. This nearly guarantees that they will have less capital to spend on employees, reducing employment opportunities and triggering layoffs for workers who are already struggling under the weight of high inflation and costly debts. These workers will then likewise spend even less, guaranteeing lower revenues for businesses accordingly, further impeding growth.
How Severe Will It Be?
For better or for worse, because of how unpredictable markets are by nature, we are effectively unable to know just how severe this bear market and recession could be. However, between the Federal Reserve’s far-from-spotless track record (2022’s hawkish Powell is, in fact, still the same person as 2021’s dovish optimist who dismissed inflation as ‘transient’), as well as the inherent lags in inflationary data such as Core CPI, the Federal Reserve could easily overshoot their tightening effort and create a depression.
This seems especially possible considering how badly the stock market has been hit while the labor market remains hot; these selloffs may become far worse as unemployment rates begin to increase, particularly if high global food and energy prices remain a problem for US consumers. However, because this hawkish monetary policy mission is consciously created by the Fed, rather than being the result of a structural failure as per the Financial Crisis of 2008, there is a chance that a meaningful economic recovery could be implemented more quickly than in decades past.
What Can Be Done?
Sadly, little can be done by working people to prevent a bear market from occurring beyond a miraculous, coordinated effort to voluntarily reduce consumer spending across the United States. Even if volatile food and energy prices continue to fall in a similar fashion as over the last few months, the Fed would still likely keep their eye on core inflation for a more complete picture. This downturn is being induced at an institutional level and is ostensibly unavoidable.
Nonetheless, for those who are long-term investors, bear markets also present myriad buying opportunities, as many shares across sectors are available at heavily discounted prices. For those who are patient and have some income to spare, building a diversified portfolio through recurring investments in safe, reputable funds remains a simple way to capitalize on poorly performing indices. While these methods by no means cancel out the horrors of economic suffering, value investing in this fashion offers consumers some semblance of wealth-building agency as we endure this business cycle.
• There have been significant declines in stock market prices since January of this year, with some indices, like the S&P 500, losing over 20% of their value. These trends sadly don’t appear to be stopping.
• A bear market is a term typically used in the context of a financial market or index that has lost at least 20% of its value from recent highs.
• While bear markets can occur for numerous reasons, the primary catalysts behind an impending bear market in the US appear to be hawkish aggression from the Federal Reserve and a bleak outlook for businesses, workers, and consumers accordingly.
• Although the exact dimensions of an anticipated bear market are unpredictable, it seems plausible that its severity could exceed that of current FOMC economic projections, though perhaps last more briefly because it is only artificially induced by the Fed.
• Unfortunately for working people, little will likely be done to prevent this downturn from happening at an institutional level. However, for those who can set aside some money for recurring and diversified long-term investments, buying opportunities will be plentiful.
The next few days will likely be full of unusual degrees of volatility in both the forex and stock markets. Let’s discuss why, and how to prepare for it, as we issue an urgent warning: Jackson Hole is here.
What is Jackson Hole?
The Jackson Hole Economic Symposium, often simply referred to as ‘Jackson Hole’, is an exclusive, three-day annual conference sponsored by the Federal Reserve Bank of Kansas City. Held in Jackson Hole, Wyoming since the early 80s, the conference is an extremely significant event for traders and investors, as it is attended by many of the biggest movers and shakers in the global financial markets. Invites are reserved for influential investors, prominent government officials, economists, and central bankers, and media coverage of comments and speeches at the event can heavily influence market sentiment and price action.
Potential Impact on Major Pairs
Jackson Hole is an extremely difficult event to prepare for because coverage is extensive, and any number of off-hand remarks could have dizzying unexpected consequences. With the conference kicking off today, traders should take caution since the forex and stock markets could easily become the wild west over the next few days, with any number of catalysts surfacing.
Tomorrow at 10 am Eastern Time, Fed Chair Jerome Powell is set to give a Symposium speech on economic outlook which will likely address the dual problems of inflation and recession, wherein he will offer hints at Fed policy plans. Depending on whether his remarks are interpreted as hawkish or dovish, this could potentially cause USD to either plummet or soar against other currencies. With a smaller Q2 US GDP contraction than originally estimated, and Core PCE Price Index (the Fed’s preferred measure of inflation) numbers also coming out tomorrow at 8:30 am, traders, Powell, and conference attendees will all have much to chew on.
Possible USD Setups
According to the EdgeFinder, A1 Trading’s market scanner tool that helps traders conduct analysis, here are three of the top-rated pairs to sell for USD bulls. All three have recently hit key support zones, though no breakouts from their clear downtrends have yet to occur. If Powell comes across as particularly hawkish tomorrow, this could prompt breakouts to the downside, and continuation for the existing downtrends. However, if he comes across as dovish, we may see support hold, along with breakouts to the upside, disrupting these downtrends.
On Friday this past week, the United Kingdom’s Office for National Statistics released the latest reports on the UK’s Gross Domestic Product (GDP), a means of measuring economic output. It was revealed that their economy grew by -0.6% month-over-month, and -0.1% quarter-over-quarter, which entails a contraction for both timeframes. Although these numbers are less disastrous than had been forecast, they are unfortunately part of a trend: New Zealand has also suffered a contraction in GDP, while the United States has experienced two consecutive quarters of contraction, a technical recession. While these declines in output are historically strange, seemingly contradicting recent phenomena like relatively high levels of employment and stock market rallies, they ought to be taken into account by traders nonetheless. Let’s explore some of the root causes of these contractions as well as factors exacerbating them as we discuss why global recession is still likely.
1) Restricted Supply
Often when inflation occurs, it is because demand for a product or service is rising at a faster rate than the supply of the product or service itself. However, this is not always the case; sometimes, inflation is caused primarily by a decrease in the supply of a thing, rather than growing demand alone. We are experiencing this phenomenon today with high food and energy prices, which explains why CPI has far outpaced core CPI (which excludes volatile food and energy prices) in many countries.
Because commodities like oil and commodity crops are scarce resources that consumers rely on to live, geopolitical problems like the invasion of Ukraine and resulting sanctions, as well as environmental problems such as heatwaves, droughts, and famines, restrict available supply. Many of these problems either are or can become chronic and near-ubiquitous, leading to persistent inflation from shortages that cannot be resolved through contractionary monetary policy.
2) Interest Rate Hikes
While interest rate hikes are a crucial monetary policy tool for curbing inflation and cooling an overheating economy, they also come with a nasty side effect: slower growth. This is because rising interest rate are designed to stifle growth by limiting consumers’ and businesses’ ability and desire to borrow money, restricting spending and thus the chances of inflation.
While lower GDP growth, even a contraction, does not necessarily create a recession, it is nonetheless playing with fire by taking steps in that direction. This is especially relevant considering that many central banks, such as the Federal Reserve and the Bank of Canada, have begun fully embracing hawkishness through unusually aggressive rate hikes.
3) Trade Deficits
Another economic factor that often quite literally detracts from a country’s GDP is trade balance. Some wealthy countries have negative trade balances, or trade deficits, created by their imports exceeding their exports. While a trade deficit might grant consumers more access to lower priced goods from other countries, it also results in a net loss of economic output that is subtracted from GDP. When trade deficits are frequent, as in the case of the US, this can theoretically severely impede economic growth, which likely contributed to the country’s technical recession. Both the UK and New Zealand have recently been reporting trade deficits as well, which is unsurprising.
4) Underfunded Pensions
Across the developed world, underfunded pension programs are proving to be a difficult problem to contend with. With large percentages of many countries’ workforces retiring, public pension systems such as Germany’s are struggling to keep up, with the German government bailing out the program with €100bn in 2021. Likewise, Social Security in the US is expected to be trillions of dollars behind in long-term funding, despite the average annual benefit amounting to less than $20,000 per recipient. Failure to improve pensions severely limits demand and growth within an economy, since a large chunk of many countries’ populations are retired adults who still spend.
5) Real Pay Cuts
Some economists worry about the possibility of high inflation combined with hot labor markets creating a ‘wage-price spiral’ where inflation persists uncontrollably due to rising employee earnings. However, the truth appears to be less fanciful, and grimmer. Even with today’s historically high rates of increasing incomes for working people, year-over-year inflation completely negates these raises in most circumstances. For example, with average hourly earnings increasing over 5% in the US, when we account for 8.5% year-over-year CPI, this implies a real pay cut of approximately 3% for working people. This entails a net loss in consumer spending, which means less revenue for businesses, and thus lower GDP growth.
6) Self-Fulfilling Prophecy
For better or for worse, market sentiment has a hand in creating fundamentals (by allocating capital), not just the other way around. Thus, if dread about a global recession continues to loom in the public consciousness, traders and investors may respond by buying and selling accordingly, potentially accelerating a coming recession with stock market and forex selloffs. In this way, the general perception of an impending global recession alone can play a large role in creating one.
Consequences for Pairs?
Lately, much of traders’ fundamental analysis has focused on how central banks respond to inflation as the primary economic threat. However, if global recession becomes a reality, there is a chance we could see central banks return to their dovish ways, which may warrant reassessing pair biases from scratch. It is also worth noting that these hypothetical dovish pivots may not occur in the face of stagflation, which unfortunately seems possible given supply concerns.
• A number of countries are currently experiencing negative GDP growth, i.e., contractions in economic output, which traders should take into account while gauging the likelihood of global recession.
• One aspect of each contraction likely involves the potentially dwindling supply of scarce resources such as crops and oil due to war, sanctions, droughts, and other potentially chronic problems. This lowers the amount of ‘stuff’ there is to buy, shrinking output.
• While interest rate hikes curb inflation within a currency’s host country, they also disincentivize consumers and businesses from borrowing money, restricting GDP growth.
• Economies prone to trade deficits, i.e., spending more on imports than they receive selling exports, impair their GDP growth by net losing output in the trade process.
• Underfunded pension systems, which cause lower benefits for elderly consumers, are proving to be an international problem, limiting consumer demand and GDP accordingly.
• Although wage growth is rising at the fastest rate in years, it still often pales in comparison to high rates of inflation, limiting consumer demand and GDP accordingly.
• Fear of impending recession can become a self-fulfilling prophecy by spooking investors and speculators, encouraging mass selloffs that create the catastrophes they were afraid of in the first place.
• If a massive event such as global recession, or even stagflation, becomes reality, this could warrant a complete reevaluation of pair biases and fundamentals.
This week the public received startling news: on Wednesday morning, month-over-month CPI (a proxy for inflation) in the United States had unexpectedly remained static, clocking in at 0% whereas a moderate 0.2% increase had been forecast. Core CPI (which excludes food and energy prices) likewise came in lower than anticipated at 0.3% month-over-month, while Thursday saw the Producer Price Index surprisingly decline 0.5% month-over-month. This prompted a mass selloff of USD across major pairs on Wednesday and Thursday, with the US Dollar Index (DXY) temporarily plummeting by 1.8% from the start of the week while stock indices soared. While demand for USD has recovered a bit since, with the DXY now down only 0.87% from Sunday, it is worth asking: has everything changed for major pairs?
Argument A: The Bearish Case for USD
A 0% month-over-month inflation rate may signal that the worst of price increases is finally over in the US. Annual inflation might have peaked, and consumers can breathe a sigh of relief now that three key events have occurred: 1) energy prices have dropped significantly due to a dip in demand, while US natural gas storage and oil barrel inventories also exceed expectations. 2) The Federal Reserve has embraced monetary policy hawkishness, and their rapid 50-75 bp rate hikes have worked, successfully restricting borrowing and thus curbing demand. 3) Despite a tight labor market, the US unemployment rate consistently hovers around 3.5%, granting a subtle degree of price stability.
Argument B: The Bullish Case for USD
Unfortunately, despite 0% month-over-month inflation being a welcome respite from high inflation, this one piece of data does not capture the full economic picture. Here are three reasons to expect high inflation to continue in the US: 1) though having fallen, energy prices could likely remain volatile and high because underlying global energy supply problems (e.g., mutual sanctions on Russian exports, OPEC’s unreliable output, energy dependence) have not been resolved. 2) Considering the scale of monetary stimulus over the course of the pandemic, and the double-digit federal funds rate that was historically implemented to stamp out high inflation, it would be shocking if these past few rate hikes were enough for the Fed to bring 40-year highs to an end. 3) The hot labor market may cause wages to further play catch-up, contributing to core inflation.
My Bias: Bullish (With a Grain of Salt)
Despite this particular cooling CPI report, I am retaining my bullish bias on USD, though admittedly with less confidence than before. The international and domestic economic conditions at work do not appear to have changed in a significant fashion as consumers still grapple with the consequences of an unprecedented money supply, labor shortages, and energy instability. However, if US inflation data continues to fall behind market expectations, I will certainly reassess this bias.
Best Pairs to Trade
According to the EdgeFinder, A1 Trading’s market scanner that helps traders conduct economic and sentiment analysis, here are two optimal pairs to trade for USD bulls: 1) GBP/USD, which has a score of -7, earning a ‘strong sell’ signal; and 2) USD/TRY, which has a score of 4, earning a ‘buy’ signal.
What is the Inflation Reduction Act in the US?
On Sunday, August 7th, the US Senate narrowly passed a budget reconciliation bill, coined the ‘Inflation Reduction Act’, by a vote of 51-50, with Vice President Kamala Harris breaking a tie. It primarily focuses on three goals: combatting climate change, expanding health insurance coverage, and reforming the tax code to reduce deficit spending. A heavily pared down incarnation of the discarded Build Back Better Act, it is expected to pass in the House of Representatives by the end of this week before being signed into effect by President Biden.
Provisions That Would Supposedly Curb Inflation
The legislation has been particularly marketed by Senator Joe Manchin (D-WV), one of its sponsors, as a means of subduing the 40-year high inflation rates currently gripping the US. The bill would allegedly do this by creating a new 15% corporate minimum tax to close existing loopholes, increasing funding for the IRS to enable higher auditing capacity, and introducing a 1% excise tax for stock buybacks. Between these measures, as well as enabling Medicare to eventually negotiate lower prices for a selection of prescription drugs, an estimated $700+ billion in additional revenue will be raised over a ten-year period. Of these funds, $300 billion will be used in lieu of current deficit spending, theoretically reducing the anticipated national debt increases as well.
Merits and Criticisms of These Claims
An optimistic outlook regarding the possible efficacy of these provisions in curbing inflation rates could highlight the reduction in capital that larger corporations would have available to allocate (for example, Amazon, FedEx, Unum, and many more companies have paid effective corporate income tax rates either at or below 0% in recent years). Net corporate subsidies stimulate the economy, increasing growth and thus inflation, while net corporate taxes restrict it.
However, a more skeptical outlook confronts the likely insignificance of these decreases in the deficit over a ten-year period. Given the United States’ $25 trillion GDP, penchant for trillion-dollar federal budget deficits, $30+ trillion national debt, and the effects of $8.9 trillion in mid-pandemic quantitative easing, a $300 billion promise in federal savings over a ten-year period is rather negligible. Slowing additions to the money supply by a fraction of a percent of GDP will likely not have much of an effect on slowing year-over-year inflation nearing double digits.
Potential Effects on Major Pairs
While it is difficult to say for certain, I am anticipating that if this legislation is signed into law, it will have either a minimal or virtually no effect on inflation and most USD fundamentals. I am personally maintaining my bullish bias on USD, and currently have open positions selling AUD/USD, NZD/USD, and buying USD/CHF. For those who are interested in finding supplemental analysis tools for gauging pair fundamentals and sentiment, consider investing in the EdgeFinder, a robust market scanner from A1 Trading.
US stock market bulls experienced a month of respite as major indices have rebounded from their mid-June lows over the following five weeks. The Dow Jones Industrial Average crossed above 31,800 on July 19th after finding support upon dipping below 30,000 in June, and the S&P 500 likewise nearly hit the 4000 level on July 20th after having touched 3650 in June. Even with mixed earnings reports and a surprise 50 basis point rate hike from the European Central Bank seemingly prompting US stocks to take a tumble intraday on Thursday, July 21, investors were treated to another ultimately positive day as indices closed higher. However, despite over a month’s worth of restored buying pressure, this recent indices-wide leap is likely not as optimistic as it seems. Let’s explore fundamentals as we discuss why the stock market rally is a mirage, as well as what investors could expect timeline-wise.
USD Trade Complications
Although a soaring USD in the foreign exchange market enables American consumers to indulge in lower priced imported goods, the flip side is that it comes at a cost for many US businesses. For those corporations that have historically sold goods and services internationally, these prices overseas are now far higher than in years past, limiting foreign demand. Thus, a highly valued USD makes US exports (approximately 13% of US GDP) less enticing for trade partners, which can substantially limit revenue for these businesses in the US, disincentivizing potential investors by theoretically limiting their earnings and share prices. Considering that USD looks primed to continue its bullish trajectory into the near future, this could be bad news for US indices overall, and by extension GDP growth as well.
Ill-Fated Consumer Demand
As is the case in every market or mixed economy, corporate earnings in the US are predicated on demand for the products and services that companies are selling. High inflation is happening in America because, as in much of the world, demand for products and services has significantly outpaced their supply; this has resulted in today’s uncomfortably high prices and a hot labor market, bolstering corporate profits to a degree.
However, this strong demand is quite unlikely to remain. Factors such as US employees’ wages and salaries failing to rise at the rate of inflation (with average hourly earnings having increased only 5.1% over the past 12 months, compared to 9.1% inflation), as well as a hawkish Federal Reserve intent on aggressively cooling the economy through raising interest rates, will impair consumer spending. This will mean less income for US businesses by extension, as well as far less money spent buying stocks speculatively as in recent years.
Global Economic Conditions
Although the US economy is currently the largest economy in the world in terms of its $25 trillion GDP and vast net wealth, much of this growth has been due to its relationship with the global economy. By relying heavily on free trade agreements, as well as foreign direct and portfolio investment, markets in the US have been transformed by globalized supply chains and reinforced by an ongoing influx of new capital.
While this approach to prosperity ostensibly comes with benefits, such as cheap imported goods and huge financing possibilities, it also comes with liabilities, such as those we are encountering today. Globalized supply chains aren’t conducive to flourishing if the world’s economies are in a tailspin while supply is unusually limited. Likewise, US businesses can’t rely on buying pressure from foreign investors if these investors have less capital to work with themselves. Thus, the US stock market is in double jeopardy, as it must endure both global and domestic economic hardships.
No More Deus Ex Machina Fed
The Federal Reserve, the central bank for the United States, has established a unique role for itself over the past fifteen years as the lender of last resort. During the financial crisis of 2008, as well as the pandemic-induced crash in 2020, the Federal Reserve undertook unprecedented measures to save the US economy through monetary stimulus. By implementing quantitative easing as well as low interest rates to escape recession via emergency expansion, the Fed made history by being willing to spend its way out of any economic crisis, stabilizing markets and causing stocks to rapidly appreciate in value.
However, with potential for recession and stagflation around the corner in the US economy, the Fed’s ability to play monetary savior is now severely restricted. With annual inflation over 9%, at 40-year highs, the Federal Reserve is forced to confront hyperinflation threats, even at the expense of consumers and businesses. The Fed won’t be able to rescue the markets with its usual dovish tricks because this time the contraction is of their own making, as a sort of necessary evil. This is incredibly bearish for US indices, because there will likely be no multi-trillion-dollar last-ditch effort to prop up corporate share prices this time.
How Long Will This Last?
Unfortunately, it appears that both the US’ and the global battles against high inflation are just beginning. With the Federal Funds Rate currently hovering around 1.75% as inflation surpasses market forecasts, and the Federal Reserve reportedly considering a full 1% rate hike with many more hikes left to go, US indices are seemingly destined for a prolonged bear market. While it is virtually impossible to know when the stock market will hit bottom, with much disappointment for short-term bulls likely ahead, long-term investors can take heart, knowing that this can also mean myriad discounted buying opportunities over the next few years.