Past peak inflation?

Signs of ‘peak’ inflation emboldens markets
There were three big stories in capital markets last week: the US midterm elections, the latest crash in the surreal world of crypto currencies, and the release of US inflation data for October. By Friday, it was the lower-than-expected inflation data that took precedence. Thursday’s report from the Bureau of Labor Statistics revealed annual consumer price index (CPI) inflation slowed to 7.7% in October, below the 8% expected by most economists, and the lowest level since January. So, for the first time this year it appeared that current rising inflation may be over for the US. While it is still too early to assume the Federal Reserve (Fed) will pivot away from its monetary tightening policy, the market euphoria following the data release was quite something. We may not have reached the actual turning point in terms of shifting economic tides, but perhaps this week’s activity confirms our suspicion of the shared belief among market participants that the current economic downturn is more likely to be shorter and shallower than some scaremongers (including the Governor of the Bank of England) suggest.

Last week also saw FTX, the second-largest crypto exchange, become a casualty of both crypto’s defining feature (lack of regulation) and the less forgiving market environment. It turns out that diehard cryptocurrency traders still prefer the stability of the money created by central banks. For us, what is most interesting about this episode is the likely impact on general credit spreads – the proverbial canary in the coal mine of capital markets during economic downturns. While FTX’s demise and bankruptcy filing is still in its early stages, talk of FTX as a “mini-Lehman” will depend on which financial institutions report large exposures (if any). This may change this week when the impact of FTX’s related hedge fund, Alameda Research, on prime brokers and other hedge funds emerges.

As we head towards the close of the year, when asset managers have a tendency to shut down exposures, last week’s positive upturn certainly felt encouraging. However, investors should not expect 2022’s market pressures to end here. The Fed’s December meeting may well cause yet another turn in market sentiment and the underlying corporate profit development, coupled with thinning seasonal liquidity from institutional investors, leaves us bracing for more potential volatility before the year ends.

Republican ‘red wave’ fizzles out
Last week’s midterm elections in the US had been labelled as the most important midterms in recent memory, with democracy itself on the ballot. But while Republicans went as far as to predict a ‘red wave’, the weekend brought news that the Democrats had retained Senate control at least, with the House of Representatives still up for grabs. The Republican party’s underperformance was an unwelcome surprise for capital markets last week, mostly because investors crave stability, which means a preference for the status quo and even political gridlock.

For markets, the real test lies in judging what fiscal policy will emerge after all the votes have been counted. The Democrats have shown a desire to increase the overall tax base in line with spending proposals – coming out at fiscally neutral – and control of the Senate could them make progress with this agenda. What the future holds for the Republican party after this ballot box set back is much less clear, and could come down to whoever gains the Republican presidential nomination in 2024. Trump is expected to announce his candidacy this week and, were he to be successful, some fear a return to fiscal indiscipline, especially in the face of slower growth. On the other hand, the unexpectedly poor performance of Republicans – particularly those linked to Trump himself – suggests the party may field someone else. That someone would almost certainly be Florida Governor Ron DeSantis. His successful re-election campaign was built around promises of sales-tax cuts targeted on everyday items, which would benefit the less well-paid. It is yet to be seen how the lower tax revenues will impact Florida’s provision of public services. It would be difficult to achieve a similar policy at the federal government level, as sales tax is levied by the states, so the equivalent would be lower income tax.

Meanwhile, Biden and the Democrats gained a fillip from the electorate, and will be poring over the voter data and surveys to divine what were the key positives. Recapturing the Senate gives Biden some ammunition to counter critics who believe his age and frailty should render him a one-term-only president. The Democrats have no obvious centre-ground alternative candidate themselves, but Trump’s early entry into the nomination race means they may wait to see how things pan out, especially if the Republican fight gets messy. With Trump involved, it almost certainly will.

Celtic Financial TV

Every month you can now watch a short market update with our head economist Chris Bailey on YouTube, simply head over to Our Channel – here you can watch our market update archive.


This article is for information purposes only – should not be perceived as financial advice. We recommend you should always speak to a financial adviser before making any investment decisions.

Please note, past performance is not a reliable indicator to future returns. Your investment may fall as well as rise, and you may not get back what you put in.