Inflation: Early Innings But Fed Down to Its Last Out
April 27, 2022
Read Time 4 MIN
A digital asset, lithium battery and hawkish Federal Reserve walk into a bar—stop us if you’ve heard this one. See why recent events have strengthened our conviction in our top themes of 2022.
At the start of the year, we believed these three themes would shape the investment world in 2022: the Federal Reserve (Fed) will hurt—not crash—the markets, wait to buy growth, and buy commodity equities. With almost four months in the books, our views remain in place, and if anything, recent events have accelerated trends that are strengthening our conviction. While Russia’s invasion of Ukraine has dominated markets more recently, we believe this turmoil reinforces the transformational potential of these themes and has shed light on the structural instability of existing markets.
Fed’s Tight Rope Act: Wages are Key to Taming Inflation
The Fed has little control over today’s goods inflation, driven by supply-chain, COVID stimulus and war. We are keeping our eyes on wage inflation, which will be clearer in the second half of this year. Wage pressures can become stickier and harder to reduce. Persistent wage inflation is really bad for financial markets.
Here’s some background. The correlation between wages and inflation has historically spiked during periods of high inflation, and continued upward pressure on wages may contribute to higher inflation.
Strong Relationship Between Wages and Inflation
Rolling 3-year correlations of the 3-year averages of U.S CPI Urban Consumers to U.S. Unit Labor Costs Non-Farm Business Sector.
Source: Bloomberg. Data as of March 2022.
Prior to the unexpected shock of COVID-19, the Fed was still in the process of unwinding the “extraordinary and unprecedented” measures it used to fight the 2008 crisis. For the last decade, the fear was that the lack of rate hikes since 2008 would make dealing with the next crisis that much harder. The last attempt to “normalize” interest rates was from 2015 to 2018, and the Fed was only able to reach 2.5% before the markets revolted. Now, stuck between soaring inflation and the potential for economic malaise, the Fed has little wiggle room to maneuver.
Every time the Fed has increased rates to fight inflation historically, unemployment has increased. The last time we faced inflation of this magnitude was the 1970s. The Fed raised interest rates dramatically, and the resulting shock caused the US unemployment rate to reach 10.7% in 1982, which was higher than unemployment in 2008.
Finally for the Fed, the sky-high inflation currently being reported might be understated. Yes, understated.
In fact, if CPI was measured today as it was in the 1970s and 1980s, some estimates show that it would be 17.15%.1 This exceeds the high of 14% during the Great Inflation of the 1970s!
Crypto’s Financial Disruption Is Here to Stay
Amid ongoing sanctions on its economy, Russia floated the idea of allowing “friendly” countries to pay for oil and gas in bitcoin or in their local currencies ("unfriendly" countries would be required to transact in rubles).
While this has yet to play out in Russia, it reinforces a cornerstone of our cryptocurrency investment thesis: we believe acceptance of stablecoins will grow dramatically (especially in emerging markets), driven by applications such as NFT-enabled ticketing, gaming and social messaging, and importantly, physical goods and services. In addition, Russia’s statement is just another indication that the decentralized finance (DeFi) ecosystem is maturing and becoming a potential competitor to legacy financial intermediaries and global investment banks.
After tech prices correct, we believe there will be good buying opportunities in tech and crypto.
Energy Transition Is a Multi-Year Trend That Is Just Getting Started
For the past six months, we have pounded the table highlighting the opportunity we see to capitalize on the underlying fundamental imbalances in the commodities market. Then geopolitical risks massively amplified these imbalances, and prices surged.
What now? Was this simply a “trade” that has run its course? No. Ignore the head fake of surging commodity prices due to war. High inflation is being caused by forces that were in place long before Russia’s invasion of Ukraine. Even if the impact of Russia’s invasion of Ukraine starts to wane, we expect commodity prices to remain at record highs given the fundamental disconnect of the market. As an example, global energy inventories remain low as energy producers significantly cut their spending over the past several years, resulting in lower supply. At the same time, demand for energy continues to rebound and is closer to pre-pandemic levels. The resulting supply and demand imbalance is fertile ground for a sustained period of higher prices.
Against this supportive macro backdrop for commodities, the energy and resources transition continues to progress. Recent events have put an even greater spotlight on energy independence and further development of sustainable production of basic essentials. Key input minerals for clean energy technologies are also seeing dramatic price increases, creating a myriad of opportunities for investors along the way, from the green metals and minerals to fuel renewable energy technologies, such as batteries technology and electric vehicles, to sustainable agriculture and food production industries.
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Investing in cryptocurrencies comes with a number of risks, including volatile market price swings or flash crashes, market manipulation, and cybersecurity risks. In addition, cryptocurrency markets and exchanges are not regulated with the same controls or customer protections available in equity, option, futures, or foreign exchange investing. There is no assurance that a person who accepts a cryptocurrency as payment today will continue to do so in the future.
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March 29, 2022
April 13, 2022
The following message reflects fund related developments and the status of the Russian market as of April 13, 2022.
March 29, 2022
September 23, 2021
The global economy, driven by the U.S. and China, was like a car going 200 miles per hour at the start of the year. Is the car still speeding, or is China hitting the brakes too hard?