Photo: Wikimedia

By Michael O’Neill

Inflation is soaring, bonds have tanked, the Fed pivoted hawkishly, Russia invaded Ukraine, and the S&P 500 embraced a bear market. And 2022 is only half over.

Who knew? Well, pretty much everybody. The signs were everywhere. They were just ignored.

In the last half of 2021, consumers noticed they were paying more and more for groceries that came in smaller and smaller packages. Auto dealers couldn’t source new cars, and some of those with inventory forced shoppers to pay the MSRP and purchase extras like rust-proofing or no sale. Used car prices were astronomical. Social media was rife with tales of a one or two-year old vehicle selling at its original purchase price. Everyone and their uncles blamed coronavirus supply chain disruptions for the problems.

House prices were through the roof. In October, Vancouver housing prices jumped 17% y/y while those in the Greater Toronto Area surged 27.7% y/y.

WTI oil prices had nearly doubled from January to October 2021.

At the same time, employers struggled to find workers, and those they found demanded more money.

Geopolitical tensions were brewing like craft beer. China’s wannabe, emperor Xi Jinping, ordered a four-day intimidation of Taiwan by flying  150 military aircraft into Taiwan’s Air Defense Identification Zone at the beginning of October.

In the same month, Russia resumed its military build-up on Ukraine’s borders, continuing an action it started in February 2021.

Equity traders didn’t care about any of the above. The S&P 500 bull market that began at the pandemic low of 3750 continued unabated, other than minor hic-cups, reaching 4712 in October and rising until year end. 

Neither did the stewards of the economy. They stubbornly maintained interest rates at almost zero.

 The highly-educated, highly-paid men and women of the Bank of Canada (BoC) and the Federal Reserve were so convinced of their own brilliance and economic models they told their constituents, “No worries, rising prices are just temporary.” 

And many investors believed them.

They forgot that this same cabal of wizards and gurus were thoroughly baffled by low inflation before the pandemic. They forgot that no Federal Open Market Committee (FOMC) or BoC Governing Council member ever explained why prices were so depressed, despite ultra-low interest rates.

But not all of them.

Those are the ones with grins like Colorado Avalanche and Golden State Warriors players and fans because they sold stocks and bonds and bought US dollars.

Fed Chair Jerome Powell finally came to his senses in December after US inflation reached a thirty-nine year peak in November. The Federal Open Market committee (FOMC) released forecasts predicting rate hikes in 2022 and announced a rapid end to the quantitative easing program.

Coincidently, the BoC was dropping hints of spring rate hikes at the same time.

They were true to their word. The BoC and Fed hiked rates by 25 basis points in March. They claimed the moves were necessary to combat rising inflation fueled by tight labour markets, strong economic growth absorbing economic slack, the war in Ukraine, another coronavirus outbreak in China, and ongoing supply chain disruptions.

As rate hikes go, especially hikes supposed to cool rapidly rising inflation, the rate increases seemed reluctant and fairly tame. Part of the reason is that both chiefs continued to mutter that inflation would return to target at some future “moving-target” date.

Pundits and analysts were not impressed, and many said the Fed “was behind the curve”. 

The Fed appears to have taken umbrage with those claims.

They reacted with what was described as a “jumbo 0.75” bp rate hike on June 15, raising the fed funds range to 1.50-1.75%  Impressed?

Don’t be. That is where it sat on January 2020, prior to the pandemic. At the time inflation was just 2.5%.

The second half of 2022 has arrived. Have we seen the worst? Is all the bad news priced in?

Not likely.

Geopolitical tensions have intensified rather than eased.

Russia is threatening “dire consequences” to Sweden and Finland for joining NATO, which is more likely after Turkey dropped its opposition. The Kremlin also announced a proportionate response” to increased NATO forces in Poland while President Putin promised to deliver nuclear missiles to Belarus.

China has an agenda that doesn’t include adhering to Western sanctions on Russian oil. It is helping fund Russia’s invasion of Ukraine by stepping up Russian oil purchases.

China also irked the G-7. The communique from the June 28 summit pushed back against China’s claims in the South China Sea. They wrote “We remain seriously concerned about the situation in the East and South China Seas. We strongly oppose any unilateral attempts to change the status quo by force or coercion that increase tensions. We stress that there is no legal basis for China’s expansive maritime claims.

Fed officials are now talking about raising interests above the “neutral rate” and analysts predict another 0.75% rate increase July 27 and a 0.50 or 0.75% move in September. That sparked a lot of talk about a recession. It is a big stretch to imagine that the same cabal of bankers that didn’t understand low inflation, then missed all the signs of a building inflation problem are capable to engineering any type of economic landing that doesn’t involve “crash.”

The long term S&P 500 technicals suggest that the index could drop to 2760, and still be in an uptrend from the Financial Crisis low of 676.

It ain’t over until the fat lady sings, and with 20/20 hindsight, we will know when she takes the stage.