Inflation Is the Biggest Threat to the Stock Market
“My biggest threat is the Fed.”
That’s a bold statement.
It’s a line from President Donald Trump’s interview with Trish Regan last week.
The president has been ramping up his criticism of the Jerome Powell-led Federal Reserve for weeks now, as rate hikes continue to be implemented.
Over the past two weeks, he has called the Fed “crazy,” “loco,” “ridiculous” and “too cute.”
Trump has made it more than clear he isn’t happy with what it is doing.
But while the Fed may be a big threat to his agenda, it isn’t the biggest threat to the stock market.
Despite the volatility we have seen lately, and a lot of talk about rising rates, that’s not what you should be paying attention to.
The real threat to the stock market is…
The Real Threat for Stock Market
Rising inflation is not what the U.S. wants.
It erodes the growth we are seeing and raises prices to lower our standard of living.
Runaway inflation like we saw in Venezuela, where its currency became utterly worthless, is a real fear that could happen in a developed nation.
The Fed doesn’t want the U.S. to be the first test.
When it comes to the Fed and its rate increases, the pace has been downright sluggish. And Trump, of all people, shouldn’t be complaining.
That’s because the Fed reacts to data.
It has a dual mandate set forth by Congress to push for maximum sustainable employment and prices.
Sustainable prices are tracked by inflation. The Fed’s target is 2%, and inflation has remained tame for quite some time now.
But unemployment, at record-low levels, is signaling to the Fed that the economy may become overheated soon.
It is trying to keep inflation calm as our economy remains steady, since rising inflation would hurt business growth and the stock market.
Today’s Rate-Hike Cycle
For Trump to call the Fed his biggest threat, he’s missing the point. He’s also going against his own words.
As a presidential candidate in 2016, Trump repeatedly attacked the Fed, stating that it was not independent, and instead was artificially keeping rates low for President Barack Obama.
Now, he wants the Fed to be loyal to him, and keep rates low.
Trump also personally said, as a businessman: “I love low interest rates,” but for the good of the nation, rates should be higher.
He was right about rates needing to be higher, and the Fed knew it.
What Trump may not realize is that the Fed has been tightening our economy through monetary policy for almost four years now.
It started by unwinding its quantitative-easing experiment back in 2014. That’s where the Fed was buying massive amounts of mortgage-backed securities and Treasurys to keep long-term rates low.
By ending that, it was a sign of tightening by the Fed, similar to multiple interest-rate hikes.
Then the Fed took a break for a year, and hiked interest rates one time, by a quarter of a point, at the end of 2015.
After that, it took another break for almost a year and started raising rates more consistently at the end of 2016.
Now, dismissing the fact the Fed has been tightening for four years, let’s look at historical interest-rate increases compared to today’s current rate-hike cycle.
As you can see, the most recent interest-rate hike cycle is moving along at a pace of just 0.07 percentage points per month.
This is by far the slowest pace.
I have it starting in December 2015. But even if you avoid that one hike and start in December 2016, the rate per month is still 0.09, almost half of the pace in the other cycles.
I wanted to point this out because the real threat to the stock market, and even Trump, is inflation.
The Real Problem With the Fed
Inflation is set to keep rising as trade wars build and the economic stimulus continues to raise prices for the masses.
The Fed is right to take it slow, because that’s what it does — react to data.
But data is delayed.
It sees it after the fact, and that’s where the real problem with the Fed comes in.
By reacting to delayed data, it keeps the Fed behind the curve.
That’s why every interest-rate hike cycle the Fed has gone through has eventually ended with another recession.
This one will have the same eventual outcome.
However, the timing of that is likely at least two years away.
That’s why I expect the stock market to hit all-time highs yet again before the end of the year.
This dip, regardless of why it happens, is an excellent opportunity to buy stocks and remain invested.
The Next Recession
Trump’s right to some extent. The Fed will eventually be the cause of the next Great Recession.
But it’s likely to blame for keeping rates too low for too long instead of raising them at a gradual pace.
For now, keep your eyes on inflation data to understand when we are nearing the next recession.
If the level approaches 3%, that’s when you need to get nervous about the market.
Until then, keep buying these volatile moments.
Chad Shoop, CMT
Editor, Automatic Profits Alert