June 23 – It’s another risk-off day on Wall Street to start trade on the final trading day of the week, with just one more week to go before the end of the month and the end of the fiscal quarter, and ahead of the critical Fourth of July weekend for the commodities. The VIX continues to trade below 14, reflecting calm on Wall Street. The dollar index is firmer while trading near 102.8. Yields on 10-year Treasuries are trading near 3.70%, while yields on 2-year Treasuries are trading near 4.71%, putting the inverse at more than 100 basis points. Crude oil prices are more than 2% lower once again today on demand worries and a stronger dollar, while the grain and oilseed sector is also mostly lower to start trade today.
Inflation is a matter of supply and demand. Prices rise when the demand for a good, service, job, or whatever is greater than the supply. Supply chains were disrupted when the pandemic hit, so decisionmakers assumed that emerging inflation was simply due to supply not being able to keep up with demand. There was some truth to that. The supply was disrupted by the pandemic, and those disruptions were expected to go away as we emerged from the pandemic, although government regulations continued to keep many of those restrictions in place well into 2021, and even into 2022. Nonetheless, it was this focus that led most decisionmakers to declare that inflation was transitory in nature, and that therefore monetary policy could remain accommodative – inflation would take care of itself with time.
But that overlooked the demand side of the equation. The whole purpose of the fiscal and monetary stimulus implemented during the pandemic was to sustain demand to keep our economy from collapsing. Nobody knew the scope of the stimulus needed, as these were unprecedented times. No decisionmaker wanted to be blamed for bringing down the economy due to being too conservative on stimulus. So, both fiscal and monetary stimulus errored on the side of over-doing it, with each type contributing roughly $5 trillion to the economy. Demand surged far above expectations, let alone the ability of supply to keep up. Inflation surged far beyond the transitory factors, becoming deeply ingrained into the economy.
The problem then became one of removing that stimulus at the proper pace, when we had no previous experience with this type of scenario. Inflation for consumer goods has already fallen below the 2% mandate, illustrating the fact that the transitory aspects of it are now in our past. However, its estimated that 4+ million people left the work force to retire early coming out of the pandemic, because their 401K’s performed so well. Yes, we can document that a significant portion of the stimulus ended up in the markets. There’s a correlation between stimulus and the S&P 500 stock index. Another 5.5 million people say they want to work, but they haven’t even looked for a job in the past 12 months. As a result, demand for workers remains stronger than the supply, keeping wage inflation strong. The Federal Reserve cannot increase the supply, but it can slow the demand. And that is what Powell referenced in his testimony before Congress this week. More work needs to be done to slow demand for workers, and that means inflicting more pain on the economy.
Crude oil prices posted notable losses again this morning as traders focus on weak Chinese economic data and prospects that higher interest rates in the West will further reduce demand in Europe and in the United States as well. Furthermore, the hawkish tone set by the Bank of England and by the Federal Reserve this week reinforced expectations of higher interest rates to come this year, with Fed Chair Jerome Powell telling the Senate Banking Committee yesterday that two more rates hikes this year was “a pretty good guess.” That provided support for the dollar, pulling it off six-week lows to push through both the 50- and 100-day moving averages, raising the cost of oil for global customers utilizing the dollar to purchase their energy needs. That tends to hurt demand as well.
Rains are again in the 6- to 10-day forecast for the dry Midwest, with some of them now working their way into the five-day outlook. We’ve been here before, and those rains disappointed. Will this time be different? Traders are reluctant to take a chance going into the weekend, so they’re taking more profits off the trading floor, and then they’ll reassess based on Sunday’s weather maps to start the week. Crop ratings should again dip on Monday, albeit at a bit slower pace. Some Midwest crops are doing quite poorly, while others are doing quite well, depending on soil types and where the rain has fallen. The range of possibilities for the national average corn and soybean yields is quite wide yet in June, but the odds argue for those national average yields sliding below trend levels – perhaps significantly. There is still no indication that we’re looking at anything close to a 2012 loss for this year’s crops. The dynamics are still different, in that heat is not a factor, and all indications still suggest that rainfall will slowly improve across the Midwest this summer, rather than get drier. Yet, that leaves end users at risk, and it keeps the speculator dreaming about the possibility of higher prices. I do believe that this is one of those years where conditions argue for USDA to make a rare reduction in its yield estimates in its July WASDE crop report, but the argument can also be made that the reduction will be relatively small this early.
