War, Inflation, and Interest Rates
The Federal Reserve is expected to raise their target interest rate by 0.25%.Such a small increase would not be likely to affect the economy or the market very much. But, both in business and in the markets anticipating what the Fed will be doing down the line is common. When the Fed officially pivots from supporting credit and pumping money into the economy to fighting the worst inflation in forty years the reaction may well be amplified. Add to that the prospect of an even wider war in Europe and there is ample reason to go long volatility buy puts on indexes like the Russell or S&P 500.
Beware of the DRINCs
We may seem at times to obsess on events in far flung parts of the world. But, as we commonly note, those events that evolve far away tend to drive financial, economic, political, military, and social events at home. When the market cares, they drive the markets and today the markets care about war, inflation, and interest rates. The market may seem irrational but what is irrational today is the world with the leader of Russia having delusions of a new Russian Empire as a remedy for his feeling humiliated by the demise of the USSR three decades ago.
Ukrainian Counter Attack
In the middle of March 2022 the Ukrainian president, Volodymyr Zelensky, addresses the US Congress and the Fed Open Market Committee meets to decide on a rate increase. Little noticed in the news is counterattack by Ukrainian forces on the outskirts of Kyiv on Russian positions. The purpose of the attack was not to regain territory but rather to destroy equipment and kill Russian soldiers. A second little noticed bit of news is that Putin is asking for the Chinese to provide him with the Chinese equivalent of MREs, Meals Ready to Eat. Russia’s attack is grinding to a halt. Morale is low. And, their supply lines are unable to bring in enough food for their troops. The cure the world’s current dilemma may be that Putin finally decides to look for a way to save face and go home to a country that will be badly damaged economically for a long time to come.
How High and How Fast Interest Rates?
The eternal quandary for the Fed is that if they don’t put the brakes on hard enough with higher interest rates inflation gets out of control and if they raise rates too aggressively they cause a recession with high unemployment. Paul Volcker was famous for jacking the Fed funds rate up in 1980 to 19% and killing inflation but the fallout was that unemployment went up for the next seven years. Today a complicating factor is a supply chain out of China that is still problematic because China persists in a zero tolerance policy of shutting down whole cities when a few cases emerge. The other is Putin’s war to re-establish a Russian Empire by invading Ukraine with an under trained and under supplied army that resorts to destruction of civilian property and killing of civilians because they cannot beat the Ukrainian army and armed population. The situation is fluid enough that predicting what the Fed will do this year is not easy. So, don’t trade alone in this market. Keep a hand on the ejection handle. And, always make sure to hedge. The best friend of the market today might well be the Ukrainian soldier making the life of the Russian soldier pure hell before making it violently short. Until that happens make sure you hedge and God bless Ukraine.