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Dow plunged on the concern of stagflation and the Russian warning

calendar 18/05/2022 - 20:24 UTC

Wall Street plunged Wednesday on the concern of synchronized global stagflation amid elevated inflation amid lingering Russian geopolitical tensions with economic sanctions. Dow also tumbled after Russia warned Finland of an appropriate military response for its NATO membership application.

On Wednesday, Russia’s Foreign Ministry spokeswoman Zakharova promised ‘a surprise’ in response to Finland’s entry into NATO and also warned the measures will be military: “It will be a surprise. This is up to our defense department. Of course, the appropriate decision will be made, taking into account the whole range of factors, and the specifics of how Finland’s membership in NATO will develop. Based on all these parameters, a decision will be made, but first of all, of course, it belongs to the military.”

Russia/Putin has repeatedly noted that NATO aims at confrontation. The Kremlin spokesperson Peskov emphasized that further expansion of NATO will not bring greater security to Europe. But at the same time, Kremlin also specified that Russia does not consider the possible participation of Helsinki and Stockholm in NATO an existential threat to Russia unless NATO set up an active military base with certain weapons.

Dow Future was already under stress Wednesday on less dovish Powell talks, in which Fed Chair may be trying to prepare the market for bigger rate hikes in September, November, and December. Powell also warned about an economic hard landing amid faster Fed tightening.

On Wednesday, Powell indicated elevated inflation will not come down meaningfully until there is a severe recession (as a result of faster Fed tightening) as-well-as supply chain resolution in China (from zero COVID policy) and Russia/Ukraine (through a peace agreement and withdrawal of the the economic sanctions). Powell also acknowledged an advanced economy (AE) like the U.S. needs cheaper imported goods/commodities from developing economies like China (Asian exporters) and even Russia (Eastern Europe). It seems that Powell is not so much confident about both (China and Russia's supply chain issues). Thus Fed may have to go for bigger rate hikes even in September, November, and December to tame hotter inflation, which may also cause an economic hard landing or even an outright recession.

Powell reiterated that Fed has no plan to hike by +0.75% in June and July. Fed will consider at least one-quarter of inflation data and evolving outlook for the next quarter. Thus Powell also didn’t rule out the possibility of +0.75% rate hikes in September, November, and December. Powell clarified that for these three meetings, Fed may hike at lower rates (+0.25%), if core PCE inflation data comes lower than being expected by the Fed, but may also hike at bigger rates (+0.75%) if it comes higher. And if inflation data continues to come as elevated as currently, then Fed will also continue to hike @+0.50% in September, November, and December.

Thus, Fed will now watch actual core PCE/CPI inflation data for April-August/September and depending upon the data and evolving outlook may hike by +0.25% (if inflation eases significantly), +0.50% (if inflation does not ease or accelerate significantly) and +0.75% (if inflation accelerates further significantly). Thus the estimated neutral rate may be +2.75% or +3.50% or even +4.25% by Dec’22. But Fed may also front-load a +0.75% rate hike in September, followed by +0.50% each in November and December to reach Bullard’s latest estimate of a neutral rate of +3.75% by Dec’22.

Powell stressed that getting inflation under control is now Fed’s primary task and for that Fed may even go for bigger rate hikes. Powell said:

·         What we need to see is inflation coming down in a clear and convincing way, and we’re going to keep pushing until we see that. If that involves moving past broadly understood levels of ‘neutral,’ we won’t hesitate at all to do that

·         This is a strong economy and we think it’s well positioned to withstand less accommodative monetary policy and tighter monetary policy. There could be some pain involved in restoring price stability -- but we think we can sustain a strong labor market

·         We like to work through expectations, and I’m not blessing any particular day’s readings, but it’s been good to see financial markets reacting in advance based on the way we’re speaking about the economy

·         We will go until we feel we’re at a place where we can say financial conditions are in an appropriate place, we see inflation coming down. We’ll go to that point. There won’t be any hesitation about that

·         You’d still have a strong labor market if unemployment were to move up a few ticks. I would say there are a number of plausible paths to have a soft as I said softish landing. Our job isn’t to handicap the odds, it’s to try to achieve that

·         There could be some pain involved in restoring price stability but the labor market should remain strong, with low unemployment and higher wagesWall Street plunged Wednesday on the concern of synchronized global stagflation amid elevated inflation amid lingering Russian geopolitical tensions with economic sanctions. Dow also tumbled after Russia warned Finland of an appropriate military response for its NATO membership application.

On Wednesday, Russia’s Foreign Ministry spokeswoman Zakharova promised ‘a surprise’ in response to Finland’s entry into NATO and also warned the measures will be military: “It will be a surprise. This is up to our defense department. Of course, the appropriate decision will be made, taking into account the whole range of factors, and the specifics of how Finland’s membership in NATO will develop. Based on all these parameters, a decision will be made, but first of all, of course, it belongs to the military.”

Russia/Putin has repeatedly noted that NATO aims at confrontation. The Kremlin spokesperson Peskov emphasized that further expansion of NATO will not bring greater security to Europe. But at the same time, Kremlin also specified that Russia does not consider the possible participation of Helsinki and Stockholm in NATO an existential threat to Russia unless NATO set up an active military base with certain weapons.

Dow Future was already under stress Wednesday on less dovish Powell talks, in which Fed Chair may be trying to prepare the market for bigger rate hikes in September, November, and December. Powell also warned about an economic hard landing amid faster Fed tightening.

On Wednesday, Powell indicated elevated inflation will not come down meaningfully until there is a severe recession (as a result of faster Fed tightening) as-well-as supply chain resolution in China (from zero COVID policy) and Russia/Ukraine (through a peace agreement and withdrawal of the the economic sanctions). Powell also acknowledged an advanced economy (AE) like the U.S. needs cheaper imported goods/commodities from developing economies like China (Asian exporters) and even Russia (Eastern Europe). It seems that Powell is not so much confident about both (China and Russia's supply chain issues). Thus Fed may have to go for bigger rate hikes even in September, November, and December to tame hotter inflation, which may also cause an economic hard landing or even an outright recession.

Powell reiterated that Fed has no plan to hike by +0.75% in June and July. Fed will consider at least one-quarter of inflation data and evolving outlook for the next quarter. Thus Powell also didn’t rule out the possibility of +0.75% rate hikes in September, November, and December. Powell clarified that for these three meetings, Fed may hike at lower rates (+0.25%), if core PCE inflation data comes lower than being expected by the Fed, but may also hike at bigger rates (+0.75%) if it comes higher. And if inflation data continues to come as elevated as currently, then Fed will also continue to hike @+0.50% in September, November, and December.

Thus, Fed will now watch actual core PCE/CPI inflation data for April-August/September and depending upon the data and evolving outlook may hike by +0.25% (if inflation eases significantly), +0.50% (if inflation does not ease or accelerate significantly) and +0.75% (if inflation accelerates further significantly). Thus the estimated neutral rate may be +2.75% or +3.50% or even +4.25% by Dec’22. But Fed may also front-load a +0.75% rate hike in September, followed by +0.50% each in November and December to reach Bullard’s latest estimate of a neutral rate of +3.75% by Dec’22.

Powell stressed that getting inflation under control is now Fed’s primary task and for that Fed may even go for bigger rate hikes. Powell said:

·         What we need to see is inflation coming down in a clear and convincing way, and we’re going to keep pushing until we see that. If that involves moving past broadly understood levels of ‘neutral,’ we won’t hesitate at all to do that

·         This is a strong economy and we think it’s well positioned to withstand less accommodative monetary policy and tighter monetary policy. There could be some pain involved in restoring price stability -- but we think we can sustain a strong labor market

·         We like to work through expectations, and I’m not blessing any particular day’s readings, but it’s been good to see financial markets reacting in advance based on the way we’re speaking about the economy

·         We will go until we feel we’re at a place where we can say financial conditions are in an appropriate place, we see inflation coming down. We’ll go to that point. There won’t be any hesitation about that

·         You’d still have a strong labor market if unemployment were to move up a few ticks. I would say there are a number of plausible paths to have a soft as I said softish landing. Our job isn’t to handicap the odds, it’s to try to achieve that

·         There could be some pain involved in restoring price stability but the labor market should remain strong, with low unemployment and higher wages

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Dow tumbled after guidance warning by major U.S. retailers, indicating more inflationary pressure on the economy and resultant stagflation

On Wednesday, Target reported a subdued report card coupled with a virtual guidance warning amid hotter inflation/input price costs. This was followed by a similar guidance warning by Walmart, Home Depot and Lowe’s earlier this week. Walmart said some of its more price-sensitive customers are beginning to trade down to private-label brands, while Home Depot emphasized the resiliency among its customer base, a sizable percentage of which is professional home builders and contractors.

The Walmart CEO said:

“While we’ve experienced high levels of inflation in our international markets over the years, U.S. inflation being this high and moving so quickly, both in food and general merchandise, is unusual. Customers walked out of stores and left the retailer’s website with fewer purchased items. More of them skipped over new clothing and other general merchandise as they saw prices rise on gas and groceries. Some traded down to cheaper brands or smaller items, including half-gallons of milk and the store brand of lunch meat instead of a pricier brand-name one. If you look at the demographics of the U.S. and lay our customer map on top of it, we’d be close to the same thing--And so you’ve got some people who are going to feel more pressure than others and I think that’s what we’re seeing.”

The Target CEO said:

“If you look at the demographics of the U.S. and lay our customer map on top of it, we’d be really close to the same thing---And so you’ve got some people who are going to feel more pressure than others and I think that’s what we’re seeing. They’re shifting from buying TVs to buying luggage--they’re still shopping, but they started to spend dollars differently.”

Bottom line:

The market is now concerned about stagflation (lower economic growth, higher inflation, and higher unemployment) amid the lingering proxy war between Russia-NATO/US over Ukraine. And this stagflation may be turned into an all-out recession if Fed goes for faster tightening and bigger hikes to slow the economy/demand to control inflation. The Fed is now also preparing the market for bigger rate hikes and a possible economic recession/hard landing instead of a soft landing.

 

 

 

 

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