Markets continued to rally in early August on optimism surrounding cooling inflation data, which led investors to think the Fed may begin to take a less aggressive stance on future rate hikes. Fed Chairman Powell, in a speech on the 26th, reiterated the Fed will not be backing down until it is clear victory can be declared on high inflation. The Fed’s greatest fear is thinking inflation is gone, only to see it return shortly thereafter. This fits and starts approach contributed to the decade-long stagflation of the 70s, when on multiple occasions, Fed officials thought inflation was receding, only to see it return soon after. Stocks and bonds sold off following Powell’s speech, with the S&P 500 ending August down 4.24%. In the long run, investors may be thankful the Fed chose short-term pain (of higher interest rates, lower growth) over protracted stagflation.
Amid a volatile international backdrop, foreign investors have poured money into U.S. assets this year. The U.S. dollar index, which compares the U.S. dollar to a basket of currencies including the Euro, Japanese yen, and U.K. pound, is at 20-year highs. Despite a pullback in crude oil prices, Europe continues to see record electricity and natural gas prices. Thus far, European utilities and governments have borne the majority of these costs, but significant price hikes are set to be passed on to consumers and businesses in the months ahead. The U.S. is feeling some of the effects of Europe’s energy woes, but not to the same extent. Europe’s natural gas benchmark price fetched as much as 10x the U.S. equivalent in August. The chart below shows a doubling in U.S. natural gas production since 2007, turning the U.S. from a major importer to one of the largest exporters. European production declined significantly over the same period as reliance on Russian imports grew. The inflationary impacts of high natural gas prices are felt in various ways via electricity, heating, and chemicals, all of which feed into energy-intensive industries. While the Fed gets most of the attention in combating inflation, U.S. energy producers will have a significant role to play.
-Jared J. Ruxer, CFA, MS