Yesterday, the market took a bath.
It was that inflation report that did it!
A 3.5% inflation rate will do that…
When many investors had hoped the Federal Reserve would make big interest rate cuts this year.
Not a chance. Well, not yet anyway.
And as we dig deeper, we unearth more evidence from history to show that lowering inflation is the last thing on the Fed’s mind.
We’ll show you what we mean momentarily. But first…
Market Data
The S&P 500 closed up 0.7% to end the day at 5,199.06… the NASDAQ gained 1.7% to close at 16,442.20.
In commodities, West Texas Intermediate crude oil trades at $85.65, down 67 cents…
Gold is $2,391 per troy ounce, up $43 from yesterday…
And bitcoin is $70,577, up $736 since yesterday.
And now, back to our story…
Just the Beginning
To refresh your memory, our position is the Fed has no incentive at all to see inflation fall.
It certainly isn’t interested in seeing it return to the long-held view that a 2% inflation rate is acceptable.
With government debt over $30 trillion and interest rates near the highest they’ve been since 2008, the Fed needs high inflation.
Why? Because higher inflation helps the government to repay old debt with newly devalued money. That makes it ‘cheaper’ for the government to pay off its debts.
And why is that? Because the government gets to rake in more tax from nominally higher wages and higher prices. It’s an effective way of increasing taxes without increasing tax rates.
In the short term, it can be effective… effective enough to reduce debt-to-GDP levels, to give the impression that the economy is improving… even though it likely isn’t.
As we say, there is a historical precedent for this. As an August 2022 essay from the Federal Reserve Bank of St Louis noted:
The U.S. has previously experienced unexpectedly high inflation rates that reduced the real value of the national debt. Perhaps most notably, the U.S. ran very high inflation rates of 12.9% and 11% in 1946 and 1947, respectively, when the country was recovering from World War II and the government had recently removed wartime price controls. This inflationary burst helped reduce the U.S. debt-to-GDP ratio from 119% in 1946 to 92% in 1948.
Different circumstances but the same intended result.
Of course, this isn’t to say that the Fed and the government will be able to manage things exactly as they want in the longer term.
As the St. Louis Fed essay goes on to explain:
Later, U.S. inflation rose more gradually, from 1.1% percent in 1963 to peaks of 9.3% in 1975 and 9.5% in 1981. Market expectations only gradually adjusted to this rising inflation, however.
After the initial burst of high inflation, it settled down. But by then, rather than the government weaning itself off spending and paying down debt… it went even further into debt.
Increased welfare programs and the Korean and Vietnam wars put paid to long-term balanced budgets, low debt, and a ‘sound’ dollar.
This all culminated in a gradual increase in inflation before it eventually peaked in the early 1980s.
Get ready for a repeat. Our educated guess is that you’ll see an improved debt-to-GDP ratio over the next couple of years as inflation remains high… you may even see the odd balanced or surplus budget.
But don’t let that fool you into thinking the Fed and the government have learned the lesson of their over-spending ways.
It will merely give them the cover they need to spend even more money, engage in more foreign wars, and devalue the money in your pocket until it’s almost worthless.
It’s no wonder so many folks struggle to figure out how they never seem to get ahead even as their ‘wealth’ increases and their incomes go up.
Bottom line: the high inflation story is only just getting started. This is the next crisis, and it’s only just begun.
More Markets
Today’s top gaining ETFs…
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ProShares Ultra QQQ (QLD) +3.2%
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Invesco Semiconductors ETF (PSI) +2.6%
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Invesco Dorsey Wright Healthcare Momentum ETF (PTH) +2.6%
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SPDR S&P Semiconductor ETF (XSD) +2.3%
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VanEck Semiconductor ETF (SMH) +2.3%
Today’s biggest losing ETFs…
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SPDR S&P Insurance ETF (KIE) -2.7%
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iShares U.S. Insurance ETF (IAK) -2.4%
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Invesco KBW Property & Casualty Insurance ETF (KBWP) -1.8%
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First Trust Financials AlphaDEX Fund (FXO) -1.1%
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Core Alternative ETF (CCOR) -1%
Cheers,
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Kris Sayce
Editor, The Daily Cut