US Inflation Waiting to Spike
Apologies for the lengthy delay between posts recently. Relocating can be stressful at the best of times, but all should be well now. Apart from the medium term US economy that is. The world has a history of overlooking signs of impending doom, and whilst US debt levels aren’t doomsday material just yet, they certainly have the ability to cause a serious problem if they are not reigned in soon. The amount of money to be made in the US economy as a trend follower during the GFC, as supposed to a blindly optimistic follower, was phenomenal. I would have to kidnap John Paulson every single day for the next four years (to get his kidnap insurance of $10m) in order to make what he made during the GFC. A background is here for those that want it.
So take the 2008 crash as an example. In hindsight, the GFC was flagged as early as 2007, when short term credit markets began to dry up on the back of major credit derivative (CDO, CMO, CDO2 etc) write-downs. It’s then only a matter of time before the inability to fund and borrow cripples those looking to carry on their daily business. Yet markets realised this, stumbled, and then continued to rally until 2008. When you explain this to someone with little financial knowledge, the words naively hopeful sometimes crop up.
So how does this relate to the current situation in the US? Sure, there are better checks and balances in place to pre-empt such catastrophes now, but the blind spot will always be those catastrophes that are caused by something which we view as too integral to discontinue without very just cause. Such as lending money to those in need to provide them with shelter. The same could be said for stimulating the US economy when Americans are in dire need of a pick-me-up.
The Brief Economics
The potentially perilous problem in a nutshell is this: the US has an interest rate of 0%, is stimulating the economy with billions of dollars of printed money and debt levels are soaring. There are two basic scenarios from here. One is that the stimulus works, is wound back as growth improves and interest rates are hiked to counteract the inflation caused by the excessive printing of money. This is what I’m hoping happens for all our sakes. The alternative is that any one of these elements doesn’t go to plan. If the stimulus isn’t effective enough, even more money is printed whilst interest rates are kept at zero, inevitably causing an inflationary boom in the near future. If interest rates are kept too low after the stimulus works then the same will occur, as there is little to counteract the copious amounts of new money floating around in a now inflated marketplace. Conversely, raising rates too early could have the effect of stifling economic growth before it’s even begun.
My point is simply that whilst there is a path through this for the US, it’s a very narrow one that will require some finesse when using the monetary policy tools available to them. Blunt instruments such as long term zero rates or trillion dollar bailout plans will not lead to long term inflationary stability. The effect of rogue inflation figures would be crippling to the purchasing power of the majority of the American population, potentially causing a mini crisis for consumer spending, credit growth, business confidence etc. The longer it goes unaddressed, the more months equity and credit markets will suffer.
What it Means for Traders
Those who weren’t afraid to trade with the trend in 2008 and 2009 made more money that an Irish leprechaun in Vegas. There is no doubt in my mind that the US could go down a path of a severe inflationary spike, which would undoubtedly be detrimental for global markets. I’m not one to trade contrarian views, so I won’t be taking any bets yet, but if the market starts to believe that it’s looking that way, I’ll be riding the S&P into triple digit figures.
In the pipeline: VIX due for another rise
Bullish on: VIX in the medium term (too many global issues to justify a level below 20)
Bearish on: Spread between brent and crude oil (blowing out again, should come back in soon)
As always, please leave any questions or comments that you may have. If you are looking for a more basic overview of trading or investing, please read www.tradingpimm.blogspot.com.