Is the Inflation Trade Back? Or will J-Pow Give It a Smackdown?

Hey There Income Hunters,


Talk about a fake breakout. Wow, did the US Dollar Currency Index (DXY) do an about-face after breaking out to the upside last week


After preaching how the dollar was the key to the deflation/inflation debate for weeks yesterday’s trade settled the argument as commodities were up across the board.


The question is, can J-Pow give this reversal a smackdown with his tough talk? 


Well, as a fellow macro analyst colleague of mine likes to say, the Fed is “trying to ride two horses with one ass.”


The Fed wants to keep asset prices elevated in hopes of increasing economic growth (one horse), while also wanting to avoid a major drop in the dollar, which could fuel a runaway inflation consensus (the other horse).


Achieving both at this point in the long-term debt cycle is an impossible task. Interest rates want to decrease and wages and rent inflation want to increase.


What will J-POW Do?


This decision must be driving J-Pow crazy …


The consumer is running out of bullets for spending just when the pressure is on to start draining money supply from the economy.



Consumers have been tapping into savings for the past six months, with the savings rate almost all the way back to pre-Covid levels.


Retail sales, meanwhile, were down over 1% in June.


Bottom line, it’s a tough time to remove excess cash from the system …


On the other side of the coin, inflation remains elevated and the Delta variant is delaying any improvement in supply chain bottlenecks.


In fact, inflation is not transitioning the way the Fed hoped for — and there is no sign it will. Just look at the percentages of consumers expecting higher prices, not lower:



Tightening Into a Slowing Economy = Big Mistake


J-Pow has been here before. He was at the helm in 2016 when the economy was barely at trend growth and just under the 2% inflation target … 


At that time the Fed felt they needed to tighten the screws preemptively, so they began tapering and then actually started raising interest rates.


Here’s the result:



Notice the initial drop in the stock market in the beginning of 2018 (first red circle). J-Pow was adamant about normalizing interest rates and decreasing the balance sheet …


He even stated after the drop in the stock market that the Fed had a long way to go. As the year wore on, short-term funding got squeezed.


J-Pow ignored short-term rates spiking and then, at year’s end t all fell apart (second circle).


This is the risk and Powell certainly knows it. If he does nothing, he risks runaway inflation. If tightens, he risks a debt crisis.


Sucks to be J-Pow!


I think he will continue to talk tough, but ultimately do very little. We will find out on Thursday.


Bring It Home 


One thing we know is that the dollar is the signpost for smart money flows.


For now, it has failed at the top of the range. The DXY range is 89.5 – 93.5, and we should see some follow through to the downside.


This will bring flows back into commodities and we should see a follow through rally to the upside there.


Then we will hear what Mr. Powell has to say.


It will be an interesting week.


Live and Trade With Passion My Friends,


Griff

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