On Thursday 13th of October we saw a huge rally in the stock market, one of the wildest days of trading in the history of Wall Street.
The price movement started at 15:30 CET (8:30 in the morning in New York) when the government released inflation data that showed consumer prices had increased 8.2% in September since last year.
The market participants reacted quickly as this data implied that the Fed would continue tightening, including a 0.75% rate hike on Nov. 2 since inflation is far from under control.
That suggests stocks should fall, and they did. The Dow Jones Industrial Average fell 1.7% in a matter of minutes.
Then the narrative took over and stocks soared. By the close on Oct. 13, the Dow gained 4.6% from the lows of the day.
What had changed?
For the most part, nothing had changed. But a new narrative took over market psychology: « Bad news is good news ».
Traders switched up their stance by saying that a more extreme Fed tightening would kill inflation faster than expected and set the stage for interest rate cuts early next year. Those expected rate cuts would be good for stocks, so it makes sense to buy stocks now!
This is nonsense for several reasons. The first is that the Fed has made it clear that they have no intention of cutting rates anytime soon.
The second problem is that if the Fed actually does cut rates early next year, it would simply show market participants that the economy was in a severe recession, which would be awful for stocks.
Let’s address the dilemma that the Fed faces with respect to inflation.
The question is: Doesn’t the Fed want inflation?
The total U.S. debt, public and private, is over $92.6 trillion. Inflation lowers the real value of debt, which makes that debt easier to pay.
So if inflation is one way to manage excessive debt by lowering the real value of the debt, why is the Fed so firmly against inflation? Why is it trying to reduce inflation if inflation is the ultimate way to decrease debt.
Of course, taxes are on the table when talking about a country’s debt. Taxation is one way that governments take money from citizens to pay off debt. But taxes are unpopular and hard to get approved by Congress. Inflation works much better.
Inflation reduces your real income since the dollars you earn are worth less and it reduces government debt because the money the government owes is easier to repay for the same reason — the dollars are worth less.
Inflation is the invisible tax increase where Congress doesn’t have to lift a finger. So again, why is the Fed combating inflation?
First we need to understand the difference between high inflation and low inflation.
Inflation is a form of theft from savers, consumers and those on fixed incomes. Imagine a mother has $50 in her purse in small bills. Her 8-year-old child wants to steal the money to buy candy but he knows that if he takes all $50 he’ll get caught and punished. Instead he takes $3 so Mom won’t notice.
It’s the same with inflation.
If inflation is 8% or 10% everyone notices, central bankers get kicked out of office and politicians lose elections. If inflation is 2%, the official target, then hardly anyone notices.
Yet don’t get fooled. The effect is still devastating over time. Inflation of 2% per year will cut the purchasing power of the dollar in half in 36 years. Then in half again in another 36 years. So the purchasing power of the dollar is destroyed by 75% in 72 years (about an average lifetime) with ONLY 2% inflation.
With 3% inflation, it only takes 48 years for the dollar to lose 75% of its purchasing power. All the while destroying the real value of money and real value of debt.
Central bankers and politicians are not against inflation. They just want to hold it at 2-3% to destroy the value of debt and not get noticed. On the other hand they are not fine with 6% inflation or higher because people notice, it makes them look incompetent and it embarrasses them.
The Fed wants to be the kid who slowly but surely steals his mom’s money to buy candy.
The ‘silent thief’, now more than ever, truly lives up to its name.
Stay alert, stay informed.
Wave Cap
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