Taps Coogan – December 12th, 2021

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Wolf Richter, creator of the wonderful Wolf Street website, recently spoke with Howe Street about his outlook for markets in light of rising inflation and the Fed’s inevitable reaction to it. Specifically, he warns that it is not inflation, but the Fed removing liquidity, that will lead to losses for bond holders and rising mortgage rates that may harm real-estate prices.

Wolf Richter on how inflation is bad for bond holders:

“The stock market can deal with inflation generally. The bond market, that’s a different situation. The bond market right now is controlled by the Fed. The Fed controls the short end of the bond market directly via its policy rate and it controls or manipulates… the long end of the bond market via quantitative easing (QE) and it’s still doing a lot of that. So, unless the Fed stops QE and starts unwinding its balance sheet… the bond market can’t really react to inflation… So you’ll have artificially suppressed yields while investors are getting crushed by inflation… If yields are allowed to rise… that means that future investors are getting deals… but current holders on those bonds will get crushed, because prices of those bonds will come down as yields are rising… For a bond holder, this environment is a horror show in both directions”

On how inflation effects the stock market:

“For stock investors, generally inflation means input costs are rising for companies but it means they can pass it on so… generally they can kind of wind their way through an inflationary environment. What stock markets cannot handle is a crackdown on inflation. So, when it raises interest rates, ends QE, (and) takes liquidity out of the market, and we’ve seen the first signs of that, stock markets are going to react to that… When the Fed is cracking down on inflation, that will be a pretty tough time for stock markets…”

On how inflation effects the real-estate market:

“When the 10-year yield rises, mortgage rates go up. When those mortgage rates, which are currently around 3%… go to 5%… it will sap demand for housing. We’ve seen that in 2018… this is going to happen again and if it is allowed to persist it will have a significant impact on the housing market.”

“It not inflation per say that the stock market or the housing market have trouble dealing with, it’s the crackdown on inflation. For bond markets, it’s the crackdown on inflation that hits the prices of bonds and it’s inflation itself that hits the yield on those bonds…”

That sounds about right. The ‘good’ news is that the economy probably can’t endure much of a tightening cycle before it slows enough to moderate inflation. Of course, finding out where that inflection point is, won’t be fun.

Enjoy the full interview above.

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