A Volatile Month in the Markets

Commentary provided by Sharps Pixley

April has been a particularly volatile month for both equities and metals, with a combination of factors affecting the markets which virtually plunged across the board in the past week. Indeed it has perhaps been surprising that there had not been even more market disruption earlier in the month given the potentially serious impact of the two principal driving forces which have come to the fore. The two are also connected in that the one is seriously impacting the other as well.

These two market drivers are rapidly rising global inflation and the Russian invasion of Ukraine.  The first was already beginning to impact U.S. markets quite severely from late last year as the nation was beginning to exit from the strictures which had been imposed to try and help control the spread of the Covid-19 pandemic.  The Ukraine war has not only created huge geopolitical uncertainty in Europe in particular, but has led to some extremely stringent economic sanctions being applied to the Russian economy to try and persuade President Putin to end his attacks on Ukraine, with seemingly little effect so far.

As Russia is a key global supplier of metal and energy commodities, foodstuffs and fertilizers, and Ukraine the latter two, these sanctions and disruptions are also having an adverse effect on the economies of nations importing these products.  Supplies are being cut off and need to be replaced by more expensive alternatives from elsewhere assuming these are even available.  Even nations like the U.S., which are reasonably self-sufficient in most, but not all, areas are not immune from the inflationary pressures thus created.

The initial demonstration of the adverse effects of all this on the U.S. economy arose with the Bureau of Labor Statistics’ latest Consumer Price Index (CPI) and Producer Price Index (PPI) data announcements mid-month which came in at 8.5% and 11.2% year-on-year increases respectively, the worst for 40 years or more.  The big worries here are what steps will the U.S. Federal Reserve take to try and bring these excessive inflation statistics, which still seems to be rising, down to its target level of around 2%.  There is even talk that the Fed may raise its target inflation rate to 3%, but it would even find such an enhanced level well-nigh impossible to meet. 

The standard tools for combating inflation are to raise interest rates, and to cut back on any other accommodative bond and security-buying programs.  But the problem facing the Fed is that interest rates have been ultra-low (near zero) for so long and although a so-called Quantitative Tightening (QT) on its accommodative bond and mortgage security buying programs is already starting to be implemented, many economists consider it as being too little too late.

Even a succession of above-the-norm interest rate rises through the remainder of the year, continuing into next, may still be insufficient to even start to bring down inflation without also driving the economy sharply downwards.  American businesses have become far too used to easy money flowing from the Fed into the markets and ultra-low interest rates supporting them.  This has seen equity markets rise to levels which many consider unsustainable.  Some well-respected commentators are even predicting a serious recession within the next couple of years – or perhaps sooner.  The recent sharp equity price falls suggest it may have even already begun. 

The resurgence of the Covid-19 pandemic in China, resulting in draconian measures to try and keep it under control, is also contributing to supply-chain worries and further resultant inflation fears.  This has been having an additional adverse impact on the markets.

In theory – in the writer’s opinion at least – the markets should be far more worried about inflation and potential Fed moves to bring it down than they appear to have been up until the past few days.  Such moves could see Federal Fund interest rate levels raised at a faster rate than at any time in the past two to three decades.  There is even talk of an almost unprecedented 75 basis point rate increase being imposed at the early May FOMC meeting, although the consensus opinion is still for the 50 basis point rise as suggested by Fed chair Jerome Powell.

But even this could be high enough to put an additional  serious dent in equity market valuations, particularly if the Fed is forecasting more of the same medicine to come throughout the remainder of the year, and beyond, which seems likely.  Investors should be prepared for a difficult few months, if not years, ahead.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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