Inflation’s Two Most Probable Paths
Three weather systems converge at the summit of Mt. Washington in New Hampshire, a weather phenomenon meteorologists refer as “The Vortex”, producing one of the windiest places on planet earth. The Mt. Washington Observatory (MWO) confirms this violent swirl produces wind speeds exceeding 100 MPH on average every week in winter, reliably presenting climbers venturing above tree-line with one of two weather scenarios: uncomfortably windy, and life-threateningly windy. Similarly, and also the result of three converging catalysts, American workers and investors in the coming decade will likely contend with one of two inflation scenarios: uncomfortable inflation, and life-threatening inflation. What are the three catalysts indicating the high probability of this outlook? What dependable gauge will soonest reveal inflation’s prevailing path? What are the implications of each to the financial markets?
It’s extraordinarily fun to spend other people’s money, but when central bankers expand the money supply at a rate exceeding economic growth, the seeds of price inflation are sown. Money-printing is the sole, indispensable cause of all inflation. While ‘The Vortex’ creates an environment conducive to high winds, specific storms trigger extreme wind velocity. The Covid19 lockdown directly resulted in producers and distributors of essential products shutting down unused facilities, disrupting the global supply chain on an unprecedented scale. The resulting supply constraints triggered the highest price inflation in 40 years. Humans are fascinating beings. As King David said, “fearfully and wonderfully have I been made” (Psalm 139:14). The behavior of groups of humans, however, as proven throughout history, is often illogical, unpredictable, and destructive, and when inflation factors into the behavior of the average consumer, the ingredients of lasting inflation have been mixed.
MWO issues Winter Storm Warnings to alert climbers of life-threatening conditions above tree-line. Many notable investors consider the yield on the 10Year Treasury bond to be the world’s most accurate economic forecaster today. Recently subverting its own 35 year downtrend line, it suggests price inflation is entrenched, and warns that America’s mid-term inflation outlook ranges from uncomfortable to potentially life-threatening.
Scenario 1: inflation moderates, causing the economy to weaken, causing the 10 Year yield to decline, allowing ‘the Fed’ to slow its aggressive tightening plans. Stocks and the economy struggle until the Fed pivots to the next “easing” cycle, at which time both stabilize and begin their respective growth cycles.
Scenario 2: inflation remains elevated near present levels or grinds higher, bringing the 10 Year yield with it, forcing ‘the Fed’ to continue tightening even as market stress elevates and the economy further weakens. This continues until a sovereign debt crisis occurs, causing ‘the Fed’ to lower rates in a high inflation environment, which would further accelerate inflation, causing unexpected and potentially devastating consequences to the stock market and economy. ¹
Climbers survive New Hampshire’s life-threatening winter winds by thinking critically and acting decisively. The present inflation is worthy of both. Think about it, Shaun.
“The wise sees trouble coming and hides himself, but the simple go on and suffer for it.” Proverbs 27:12” ~Proverbs 27:12
1 Inside TRADESMITH, by Justin Brill, “This Is the Worst Case Scenario for Stocks”, June 14, 2022
The opinions voiced in this material are general, are not intended to provide specific recommendations, and do not necessarily reflect the views of LPL Financial. The economic forecasts set forth in this commentary may not develop as predicted.
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