Andy_Hecht

Covid in 2020, Inflation in 2021, Geopolitics in 2022

CBOT:ZB1!   T-Bond Futures
The Chinese New Year just passed, and we are now in the year of the Tiger. “May you live in interesting times” is often considered the translation of a traditional Chinese curse.

  • Markets reflect the economic and political landscapes
  • In 2021 rising inflation was at the center of the stage
  • Inflation will continue to impact markets in 2022 and beyond
  • Geopolitical concerns are rising- China and Russia become allies at the Winter Olympics
  • Iran and North Korea pose threats- Significant moves could come from geopolitical events over the coming months

In early 2022, the world continues to suffer from COVID-19 variants and the fallout from economic and political policies that addressed the global pandemic. Markets are nervous with choppy price action in markets across all asset classes. The stock market has been threatening to correct to the downside, and bonds have declined on the back of the prospects of rising interest rates. Cryptocurrency volatility continues to be at head-spinning levels. Commodities remain in mostly bullish trends, but bull markets rarely move in straight lines.

As we learned in early 2020, the most significant market volatility comes from unexpected events. In early 2022, the world is anything but a stable place as tensions are mounting and the US’s role as the leader of the “free world” is challenged. In 2020, the pandemic caused wild markets price swings across all asset classes. The central bank and government tools addressing COVID-19’s economic fallout dominate markets in 2021. In 2022, the geopolitical landscape appears to be the factor that could cause lots of uncertainty and price variance.


Markets reflect the economic and political landscapes

We follow trends as they reflect the crowd’s wisdom. The old sayings “buy the rumor and sell the fact,” or “sell the rumor and buy the fact,” refer to the market’s habit of fading news leading those who follow the news to lose. Over time, macro and microeconomics and the geopolitical landscape determine the path of least resistance of prices. However, market volatility can cause dramatic short-term moves that defy rational, logical, and reasonable fundamental analysis .

In early 2022, markets continue to emerge from the global pandemic. The impact of monetary and fiscal policy tools that stabilized economic conditions has significantly impacted markets that will long outlive the pandemic. Moreover, geopolitical dynamics are shifting, increasing the threat of hostilities across the globe.

The pandemic caused market volatility in 2020 and 2021, but in 2022, the price variance could increase as the economic and political landscapes are creating more than a bit of uncertainty, and markets hate uncertainty.


In 2021 rising inflation was at the center of the stage

In 2021, inflationary pressures rose to the highest level in four decades. The consumer price index rose by 7%, while the core CPI , excluding food and energy, rose 5.5%. The producer price index increased by nearly 10%. US GDP also moved appreciably higher.

The Fed did absolutely nothing as inflation rose, blaming the economic condition on “transitory” pandemic-inspired supply chain bottlenecks. However, a four-decade high caused the central bank to realize that inflation was more structural than temporary.

At the November and December FOMC meetings, the rhetoric became more hawkish, but while the Fed talked a good game, the only change came as they began tapering quantitative easing. Tapering was not tightening as the central bank continued to purchase debt securities. In early 2022, the hawkish squawking increased in volume at the January meeting, but QE will not end until early March, setting the stage for liftoff from a zero percent short-term Fed Funds rate.

In 2021, asset prices increased with double-digit percentage gains in the leading stock market indices, commodities , real estate, cryptocurrencies, and other assets. Inflation erodes money’s purchasing power, so the increases in asset prices were a mirage as they reflected the decline of fiat currency values.

About halfway through 2021, the US government bond market began screaming that the Fed was behind the inflationary curve.


As the chart highlights, the US 30-Year Treasury bond futures fell from the July 2021 167-04 high to 159-31 at the end of December 2021. In early 2022, the long bond’s decent continues with the bonds trading to a low of 150-26 last week, the lowest level since May 2019. The move below technical support at the July 2019 152-28 low could be a gateway to a test of the 2018 136-16 bottom, meaning inflation will continue to push interest rates higher.


Inflation will continue to impact markets in 2022 and beyond

Last week, we found out that CPI rose by 7.5% in January 2022 with the core reading up 6% as inflation continues to rise. Crude oil is trending towards $100 per barrel, and other prices continue to appreciate. Bull markets in commodities reflect inflationary pressures, but they rarely move in straight lines. Raw material markets tend to be far more volatile than stocks or bonds, but they are inflationary barometers. All signs point to a continuation of higher lows and higher highs in the commodities asset class.

At the end of last week, gold was above the $1800 pivot point and threatening to break out to the upside.


Gold is the ultimate inflation barometer, and the price has been making lower highs and higher lows since March 2021. Like a tightly coiled spring , the wedge pattern in the gold market suggests that a substantial move is on the horizon. Since the turn of this century, every price correction in the gold market has been a buying opportunity. The odds continue to favor the upside when gold abandons the $1800 pivot price.

Inflation is a challenging beast as it creates a vicious cycle that pushes prices higher and fiat currencies lower. In early 2022, the supply chain, labor shortages, and rising input costs continue to pour fuel on the inflationary fire. The shift in US energy policy handed crude oil’s pricing power back to the international oil cartel and Russia. Higher oil prices increase input and transportation costs. Addressing climate change by supporting alternative and renewable energy sources is a multi-decade program. The current US administration is not prepared to increase oil and gas production to lower traditional energy prices. Energy is a root cause of inflation , and the current course of monetary policy tightening is not likely to reduce inflation if oil prices continue to rise in 2022.

With core CPI at the 6% level, the Fed would need to increase the Fed Funds rate by twenty-five basis points twenty-three times to push real short-term interest rates into positive territory. The latest FOMC forecasts of a 0.90% Fed Funds rate in 2022 and 1.60% in 2023 means real rates will remain negative, fueling inflation over the coming months and years.

Meanwhile, the Fed is in an unenviable position as higher rates will cause the cost of funding the $30 trillion debt to soar. Each twenty-five basis point increase costs $75 billion in debt servicing costs each year. At a 5.5% Fed Funds Rate the price tag is a staggering $1.65 trillion per year.

The bottom line is that the US central bank and government are unwilling to swallow the bitter pill necessary to address inflation , which will continue to rise. Just as in all markets, the trend is higher, and it is always your best friend, even when it is devastating for the economy.


Geopolitical concerns are rising- China and Russia become allies at the Winter Olympics

The US faces more problems on the economic landscape. We may remember the 2022 Beijing Olympics as a watershed event, not for athletics, but a meeting between the Chinese and Russian leaders.

President Xi pledged support to President Putin over Ukraine. With over 100,000 Russian troops at Ukraine’s border, it may only be a matter of time before an incursion. The US and Western Europe consider Ukraine part of a free Eastern Europe, and Russia believes the country is eastern Russia. A Chinese and Russian alliance complicates NATOs defense of Ukraine’s sovereignty.

Meanwhile, China is committed to reunification with Democratic Taiwan. Presidents Xi and Putin also agreed that the US should not interfere with Chinese plans to bring Taiwan under its umbrella.
An alliance between China and Russia over Ukraine and Taiwan has far-reaching geopolitical consequences as it could render sanctions impotent. Russia agreed to supply oil and gas to China via its pipeline system, which fills Russia’s pockets with funds and fuels China’s economy and growth. US allies in Europe and worldwide depend on Russia and China for commodity flows and commerce. The western alliance that supports sovereignty for Ukraine and Taiwan weakens as Chinese and Russian ties strengthen.


Iran and North Korea pose threats- Significant moves could come from geopolitical events over the coming months

The rise of China and Russia comes at the expense of the United States, the current leader of the free world. Moreover, it encourages US enemies worldwide.

Iran continues to enrich uranium as the Biden administration attempts to negotiate a nuclear non-proliferation agreement. The US has an ulterior motive as higher oil prices make increased Iranian production attractive in the current environment. Higher oil prices strengthen Iran’s negotiating position in dealing with the US and Europe.

Over the past weeks, North Korea has been test-firing rockets, moving forward with its nuclear weapons program. The hermit nation is now a nuclear power with weapons of mass destruction that could reach the US. Chinese and Russian cooperation only enhances North Korea’s position as an emerging nuclear power.

The bottom line is that markets reflect the economic and geopolitical landscape. Uncertainty in early 2022 is at the highest level since the Cold War. As Russia increases its global sphere of influence, it is now the most powerful OPEC+ nonmember, making production decisions alongside Saudi Arabia. Moreover, Russian allies in Cuba and Venezuela are close to US territory, posing a substantial threat to the US mainland if a war in Europe is on the horizon. Aside from conventional military hostilities, technology has created new weapons that could draw the entire world into conflicts.

COVID-19 dominated markets in 2020, and rising inflation was at the center of the stage in 2021. In 2022, the geopolitical landscape has become a minefield of potential problems likely to impact markets across all asset classes.

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