Thoughts From The Divide – Pulling the Plug

“We decided to speed up the reduction in our asset purchases

Just in time for Christmas and the New Year, the Fed is playing the part of the Grinch. While the Dr. Seuss character stole Christmas paraphernalia from the Whos of Whoville (including one J.P.Who…?), the Fed is dialing back the stimulative juice.

In addition to doubling the rate of tapering “in light of inflation developments and the further improvement in the labor market”, the infamous dot plots are now “projecting three rate hikes next year, another three in 2023, and another two in 2024”. Markets aren’t quite sure what to make of the announcement, with Fed futures showing traders expect “the Fed to start raising rates in April”, but if PPI, which jumped 9.6% YoY, “the most since records began in 2010”, is any indication of what’s to come for inflation, there may be yet another change in plans.

“Approaching a breaking point”

As the Fed is withdrawing some fiscal juice at home, power and energy problems (and their consequences) continue abroad.

Thanks to some piping “defects” found in a pair of nuclear reactors, France is shutting down a few nuclear powerplants for maintenance, which is expected to result in a drop of roughly 1 TWh of production. As this article explains, France “typically exports electricity” and is relied upon “at peak times in markets such as Germany, Italy and Britain”. Beyond just affecting price (the price of power for delivery in January jumped on the news of the closures), there are several measures under consideration to relieve a strained power grid, including “briefly cut[ting] power of some large manufacturers” and “rotating regional power cuts”. Higher prices or restrictions likely will not help German PPI, which came in at a nose-bleeding 19.2% YoY, the highest since November 1951. 

Meanwhile, China’s halting urea exports have knock-on effects beyond just agriculture. As this article explains, Australian supplies of diesel exhaust fluid derived from urea are drying up, with suppliers already rationing the additive. There are additional concerns that a disruption in diesel trucking will, in turn, disrupt Australia’s fuel supply as “the vast majority of petrol and diesel in Australia is carried by trucks rather than trains or coastal shipping tankers”. 

P.S. While there are ongoing arguments over whether QE directly affects stocks, a paper from earlier this year develops a new hypothesis about price-inelasticities in markets and finds that an additional $1 of investment leads to an increase in aggregate market valuations “between $3 and $8”!