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Where is the market going? What kind of risks do we need to be aware of? There are three or four things to pay attention to right now. The FED, interest rates, inflation, Covid, China, the government, and geopolitics. Do any of these present a risk to markets?

Okay, more than three or four things, but the first three can all be lumped together. Interest rate policy is enacted by the FED and what happens with interest rates has a direct impact on inflation. Furthermore, the government also has a chance to impact inflation.

And I apologize if we bounce around a little from topic to topic.

The FED, Interest Rates, Inflation

The government and the FED have a lot of control over what inflation is going to do. We had a lot of liquidity injected into the market because of the pandemic, and there’s a very good chance we’ll see more of that in the near future.

A $3.5 trillion bill is circulating through Congress right now. If this bill gets passed, we’ll have a lot more liquidity injected into the market. That’s likely to be a large tailwind for inflation (which is already running much hotter than expected). If the FED continues to provide an accommodative monetary policy, we’ll see inflation get out of control, and they’ll have to increase interest rates much sooner than they had planned.

Covid

Covid is still hanging around. 75% of the country has received at least one shot and now the administration is pushing booster shots. This is even after the CDC and the WHO have insisted on holding off on a third shot until less fortunate countries have a chance to get more of their first poke. The numbers need to level off soon or I fear lockdowns may rear their ugly head, and we all know how much the economy liked that the first time around.

China

China is a new story. Specifically, Evergrande. The ginormous real estate company is on the brink of bankruptcy. Comparisons have been made to the collapse of Lehman Brothers during the GFC (great financial crisis). We’ll see what happens and if the Chinese government decides to step in. Ripple effects through the global monetary system are possible.

Geopolitics

The last story is geopolitics. This has to do with the deal the US and Australia struck to help the Australian government build nuclear-capable submarines. It angered France because they already had a deal with Australia to help them build submarines (not nuclear-capable though). Britain feels pretty good because they helped broker the US/Aussie deal. Most likely, this will end up being only noise but could present a risk to markets. Something to keep your eye on.

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There’s a lot going on in the world right now. Supply disruptions, stimulus payments, excess savings, labor shortages, and infrastructure are all playing a role in economic policy. In today’s post, I want to try and explain how they all play a factor with regard to how the FED determines policy.

Supply disruptions

Inherently, supply disruptions don’t have much to do with how the federal reserve coordinates monetary policy. The biggest supply disruption we have at the moment involves semiconductors.

The wide applicability of semiconductors makes them very important in product development and deployment. What’s more, the number of semiconductors needed just keeps growing.

The bad news is…there’s a supply shortage. That creates upward pressure on price. Not only for the semiconductors themselves but also for the products that use them.

Stimulus payments and excess savings

When Covid hit, the world shut down. People were out of work, so they didn’t spend money. People didn’t spend money, so businesses started losing revenue. In order to prevent total economic collapse, the government sent stimulus checks to qualifying individuals and boosted unemployment.

A lot of people saved this “extra” money and recently started to spend it. Jobs are starting to come back and the global economy is starting to look healthy. Confidence inspires spending. Increased consumer spending is good for the economy.

Labor shortages

Labor has become a big topic of conversation. Not only do we have more jobs available than we have people to take those jobs, but workers are quitting in large numbers. Both of those factors can have a large impact on wages.

Employers are having trouble filling roles. How can they attract applicants? Better wages and benefits? For those that can afford bigger payroll, that’s the avenue they’re using. That puts upward pressure on wages.

I also mentioned workers are quitting in droves. Employees are demanding to be fairly compensated and enough of them are banding together now. Improved benefits and increased wages are becoming more likely.

Wage inflation helps feed the price inflation narrative. The prices for products and services go up because of supply and demand factors. Wage inflation increases due to supply and demand dynamics.

These two inflationary pressures feed on each other. Wages go up so workers can afford more. Prices go up because workers can buy more, and so on.

Infrastructure

News broke about a new infrastructure bill (Source). On top of, already, record-breaking government spending, that’ll juice our GDP numbers for 2021.

I don’t have much else to say about this other than the spending involved will create inflationary pressures AND I’m proud there was bipartisan support for this bill. Not something we see very often anymore, so I’m happy it turned out this way.

The Federal Reserve

With all of that said, what’s the federal reserve going to do? If inflationary pressures are as hot as they seem, I fear the FED will have no option, but to end their accommodating stance on monetary policy.

They’ve already indicated that a rise in interest rates in Q3 or Q4 of 2023 is likely. They claim that they will let inflation run past their 2% target but by how much? At one point do they say enough is enough?

That’s a tough question to answer. I think in this situation, they’re talking bigger than what they’ll actually deliver. It’s all well and good if they say they’re going to let inflation run, but we’ll see what actually happens when that gets here.

What Currently Present a Risk to Markets?