This has been a hot topic for analysts for the last 1 month. There were various discussions that the inflation monster is finally here after waiting patiently for 13 years since the 2008 GFC (Global Financial Crisis). The markets were spooked last week when the Fed Dec minutes revealed a more hawkish stance than previously thought.
Some are now calling for 4 US rate hikes into 2022. Futures are pricing in a quicker tightening than before, as 30 years US treasuries go above 2%. Everyone is talking about how this might sink the stock markets. Are we supposed to panic now or is this a myth? My 2 cents worth below.
Let’s just take a step back and look at the build-up to today. We had the 2008 GFC which resulted in all central banks being forced to cut interest rates aggressively. This was to save the financial system as banks started to collapse under the weight of collapsing CDO debt value. The cuts were so fast and savage that very soon, we went into the unchartered ZIRP (Zero Interest Rate Policy) zone. Europe rates even went negative. There were no economic books to refer to as we had never been in this state before. And yet we stayed here for so long.
Theoretically, rates cannot stay at zero as a recovering economy will result in overall inflation raising its ugly head rapidly. But surprisingly, that didn’t really happen for a very, very long time. With cheap money available everywhere, this has translated to asset price inflation instead. Every asset class rose as hot money chased after them. Those that went full-on into debt to buy assets became the savvy heroes who made it big.
The prudent risk-averse investor lost out as the newly-crowned cowboy investors bet the house and the barnyard on anything that moves. The price corrections were seen as buying on dips opportunities. Flash crashes lasted only for a short time and new investors easily forgot the last dip.
Then Covid came. In Mar 2020, the world dropped off the cliff. Supply chains stopped working. I personally saw the Wellington harbour filled to the brim with raw materials but going nowhere during my last vacation to NZ in Feb 2020. Over a matter of weeks, world trade volumes easily reduced by 90% as we grapple with the emerging pandemic. No one had a clue what was happening as country after country decided to close their borders.
And now we are into the 3rd year of the virus. We have witnessed many start-stop actions in 2021 where the recovering economy was pushed back by the 2 new mutant strains. Supply chains are trying to get back to pre-2020 levels but multiple shocks constantly disrupt the recovery. The Fed did one of the biggest money printing exercises last year to support its citizens with a mini-UBI (Universal Basic Income) program where monthly 1.2k cheques were issued to all like candy. It is estimated that 30% of all existing US Dollars were newly created in 2021 alone.
So is it any wonder that they are now seeing food price increases by the same quantum (+30%)? US Dec CPI at +7% was the highest in decades. Oil prices also continue to face upward pressure even after Biden released some strategic reserves late last year. There are many articles predicting that inflation is being underestimated and the futures markets are now priced up to 4 rate hikes this year.
Where do we go from here? I believe that this inflation shock is transient and it may not last long. If you look at the relatively low overall inflation for the last 10+ years, technology may have played a big part in suppressing inflation as productivity soared. We had big developments in Cloud Computing, AI, Blockchain and Big Data that changed the way we worked and Covid accelerated it further.
But in Mar 2020, the world decided to stop working altogether as we figured out the one in a hundred years pandemic event. Mother Earth was given a breather as activities and trading volumes collapsed by at least 90%.
Vaccines rollout just celebrated its 1 year anniversary today. A broken-down global supply chain takes a while to get back to its former glory. The ramp-up takes time because Delta/Omicron put a knee jerk brake on the momentum.
So the tight squeeze we see in commodities like microchips and oil makes for great inflation stories. Don’t forget that after Mar 2020, we are now coming from a low denominator base. At a base of 100, a 10% increase is only 10 points. If the base had dropped 90% to 10 now, a 5 points increase from 10 is a whopping 50% jump!!! That scary percentage will surely sound the alarms for the hawks, no? Fear drives news headlines and everyone goes into a feeding frenzy of inflation doomsday scenarios.
It will take a while to ramp up the supply chain momentum again. So like Technology over the last many years, the manufacturing engines will take at least 6 to 9 months to go back to their former glory. The expected future inflation into 2022 will likely dissipate as we get back to normal. Of course, this is also dependent on how Covid progresses.
I believe that we are at the tail end of Covid. Omicron is a good signal that it is becoming like the common flu. We have more new medicines coming online to treat it, as we gather more data to study it. People are tired of the lockdowns and want to treat it like an endemic. Though the world had changed a lot in the past 24 months, resilient human nature will bounce back to fight and conquer the virus successfully.
The flavour of the month is inflation hysteria. That could fade into the background in a couple of months as the mighty global supply chain rev up towards levels seen in normal times and the virus becomes totally endemic, a way of life. A number of market watchers I spoke to are still relatively invested in stocks and see dips to buy. Even as the market stock index is currently supported by a narrow group of tech names, they see the rest of the stocks doing a catch up as the economy recovers. I should selectively look at the cyclical ones which can benefit in a rising rate environment.
Alternatively, there is the crypto market. I have increased my investments in this space. I try to stick to only the top 10 to 20 cryptocurrencies that have volumes and depth of liquidity. BTC is a HODL position for accumulation and the recent 40% correction from the new high is likely to hold at the 40k levels.
I have been recently inspired by ETH after reading the book “The Infinite Machine” on its short history and started to accumulate it again. The book gave me a better understanding of its short history and what it can be when ETH2 is launched this year as a Proof of Stake coin that consumes 99% less electricity. It might also overtake BTC in market cap this year too.
Layer 2 cryptos that try to solve the high ETH gas fees are also looking interesting as their creators are also ETH founding fathers too eg Gavin Wood (main programmer of ETH) – now Polkadot. Cardano (Ada) has Charles Hoskinson (fired ETH ex-CEO). Avalanche (AVA) and Polygon (Matrix) are also some that want to pivot to Proof of Stake and accelerate the speed and number of transactions. This will help further DeFi development.
Exciting days ahead in 2022 as I complete the first module of my FinTech full-time course this week. There is much to look forward to indeed…
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