A Vaccine for Inflation?

The COVID Delta variant killed over 10,000 a week in the U.S. from mid-August to mid-October in what has been dubbed an epidemic of the unvaccinated. Since the first of November, deaths have ramped down from 6,000 a week to about 1,000 last week. 

Relieved that the worst might be behind us, investors pushed the U.S. stock market to all-time highs seven times in November, up 2.48% at the peak from the end of October. Though inflation was reported at 6.2%, a 30-year high, the Fed reacted, saying it may accelerate ending its monthly bond buying and begin raising the Fed overnight interest rate earlier in 2022 than previously announced. Stocks dipped briefly on the news but recovered quickly. 

Bonds started to sell off and the 10-year Treasury yield rose towards the 1.72% peak reached at the end of March before inflation grabbed the headlines. Since bonds are the bulwark of the Lifestyle Floor allocation in our retirement income plans, this means we might be able to resume building out your retirement income bond ladders soon. All seemed good with the continuing direction of the recovery.

And then on Black Friday came Omicron. Detecting Omicron requires gene sequencing, not just the usual nose swab. Four days after the variant was named and its genetic sequence posted, it has been detected in hundreds of cases in 21 countries, obviously circulating with travelers for some time under the radar. It’s too soon to know whether current vaccines will stop it.

It’s also too early to know what impact the new strain will have on the economy. The markets reacted to this uncertainty with a -5% drop in as many days at the end of the month—guarded but not panicked. November closed -1.5% below October giving back the month’s gains. We can expect increased market volatility as new information, good and bad, hits the headlines.

A view of changing inflation cycles is emerging. Initially the stock market, buoyed by stimulus dollars, and housing, cars, work-at-home remodeling, and home and office goods, driven by high consumer demand, all inflated from the epidemic’s initial impact on our lifestyles. This may reverse as the economy shifts away from pandemic cocooning, reducing demand and deflating prices for goods that have risen the most recently. 

More recently inflation has shifted to food and energy, driving the 6% peak reported in November. The next cycle may show increased demand for services instead of goods, with rising rents, healthcare and the myriad small service businesses in our neighborhoods raising prices to cover the new higher cost of labor.

What isn’t clear is if and when the inflation in the stock market might unwind. There is concern that as the Fed speeds up its response to inflation, inflation is mutating like the virus, and the Fed’s fix may end up mistargeted. Omicron complicates this view and may alter the Fed’s intended tightening. 

Should the new strain infect the economy once again, the Fed may need to slow down its plan to end stimulus and raise its overnight rate. But if inflation mutates and continues at a high rate even as the economy reels from Omicron, the Fed may find itself with an economic vaccine that no longer works.

A closing note: Happy anniversary, it’s been 20 years since the collapse of Enron, in which thousands of stockholders lost the value of their stock and employees lost their jobs, 401(k)s and pensions, top executives were convicted of fraud and sent to prison, and the accounting firm Arthur Anderson dissolved when found guilty of shredding evidence—a human, all too human definition of ‘business risk’ for investors.