New Threat to Inflation

The week started with mixed feelings. Investors broadly ignored the Federal Reserve (Fed) members’ latest warnings that the interest rate cuts won’t come as soon and as fast as priced in by the financial markets. Equity bulls look determined to keep the Xmas magic alive. Big banks like Goldman Sachs also add fuel on fire, citing that the dovish Fed is good for stocks. We all agree. Dovish Fed is good for stock valuations, yet, how long the Fed could remain dovish if the economy heats up?

Anyway, attention was rather on a burst of mergers and acquisitions worth around $40bn that hit the wire on Monday. The S&P500 advanced to a fresh ytd high yesterday, while Nasdaq 100 renewed record for the 2nd straight session. Amazon rallied 2.73% yesterday, as Nvidia tested the $500 offers for the 3rd time since August. Apple was an exception to another euphoric day of trading, as its shares fell after hitting a fresh high last week on news that China is extending its ban of foreign device usage and on news that the company will halt the sale of Apple watches on a patent dispute.

Reality check

Yesterday’s trading was also marked by geopolitical tensions and news. The week started with the news that the world’s leading shipping companies decided to halt transit through the Suez Canal due to attacks by Iran-backed Houthis on commercial ships. The latter increases the risk premium of using the short-cut of Suez Canal and encourages ships to go around Africa instead. Considering that around 12% of global trade goes through the Suez Canal, and the deviation around Africa adds between 6 to 14 days to shipments, the Red Sea disruptions delay the shipment of goods but also increase the price of shipping the goods. This, coupled with the disruption in Panama Canal due to drought-induced delays put the global supply chains under pressure, again.

Big shipping company stocks gain as they can increase their prices, energy companies also started announcing that they will avoid transiting via the Red Sea region. Crude oil and natural gas prices come under a renewed positive pressure.

An extended period of disruption in global trade ways should not only sustain energy prices, but also put a renewed pressure on global supply chains and shipping prices. The latter is a threat to inflation. Remember, the pandemic-related supply chain disruptions were the major reason that sent inflation to almost 10% in the US. Middle East tensions are expected to have a modest impact compared to the pandemic disruption, but the rising shipping costs – if they last – could lead to an uptick in inflation. Therefore, it is well possible that the Fed uncorked the champagne before winning the inflation battle.

As of today, upside risks to inflation persist and build up, and this will inevitably dawn on investors sooner rather than later. A stronger case is being built for a sizeable downside correction in both stock and bond markets into next year.

This being said, the Eurozone’s November inflation numbers are out this morning; headline inflation is expected to have eased to 2.4% and core inflation to 3.6% in November. Inflation in Canada is expected to fall below the 3% mark. Sufficiently soft inflation figures could cheer up investors, but it’s worth keeping an eye on shipping news.

Swissquote Bank SA
Swissquote Bank SA
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