Peak Inflation Is Not The Issue

The comments below are an edited and abridged synopsis of an article by Michael Pento

Record-high inflation combined with a hawkish monetary policy is slowing the US economy drastically. This will cause inflation to roll over along with bond yields, but that doesn’t indicate a new bull market. It is much the same process that led up to the financial crisis of 2008.

Peak Inflation Is Not The Issue - BullionBuzz - Nick's Top Six
A man standing on a mountain top uses a spyglass as he looks to another distant mountaintop in his search for higher yield.

The difference is that inflation today is greater than it was 15 years ago—9.1% for June, which is closer to 20% if calculated using the same method as for 1980. That is much more than the 4.1% in December 2007.

The peak of CPI is probably here, and falling inflation would be great news for the stock market as long as it didn’t come with crashing economic growth. During the last three recessions, the Fed had to reduce interest rates and/or undergo QE programs to boost the market. Even so, results were not immediately visible. During the dot.com recession, the Fed had to reduce borrowing costs by 475 bps before the market bottomed, and that took nearly two years.

Core CPI spiked at 0.7% m/m in June, a faster rate than the previous month, and it was higher by 5.9% from the previous year. Real hourly earnings decreased 3.6% YoY. Despite this, a plunging growth rate of M2 money supply and the nascent destruction of the Fed’s balance sheet should send the rate of change of inflation lower in the months ahead.

For now, high inflation is undermining the economy and evidence of the recession is everywhere.

Inflation and bond yields are possibly peaking, but that doesn’t mean we should buy stocks. The 10-year bond topped out at 5.2% in July 2007, and the Great Financial Crisis began a few months later. The cyclical bottom in the benchmark Treasury yield didn’t occur until the end of 2008. If you bought stocks in July 2007 because the Fed was done tightening and the top of bond yields were in, you made a big mistake. Between July 2007 (cyclical top in yields) and December 2008 (cyclical bottom in yields) the S&P 500 shed 43%.

While there is more room to the upside of the Fed Funds Rate, long-term bond yields and inflation have likely made their cyclical high. Nevertheless, those conditions do not lead to an imminent bottom for the stock market. For that to occur, liquidity and credit conditions must improve significantly.

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