Markets in all assets had a brutal sell off in June, Everything from stocks, commodities to even crypto currencies were not spared. What was the catalyst behind the sell off? Aggressive interest rate hikes by the Federal Reserve in the last FOMC meeting.
The inflation rate has been getting out of control and has reached levels where it is of great concern to the Federal Reserve. So in its June FOMC the committee decided to do the unthinkable and raised interest rates by a staggering 75 basis points. the biggest increase since 1994. This was the catalyst that triggered the sell down in the second half of June. It has also telegraph its intention to the markets that another 50 to 75 basis hike is on the cards for the next July meeting as well.
Agriculture commodities prices are tanking
We have a saying in the business where you never fight the Fed. Inflation this time around was brought up mainly by supply disruptions caused by the Russia Ukraine war. There was no real increase in demand for commodities in this latest bull cycle, unlike the 2008 commodity market which was driven exponential growth in China demand. So raising interest rates aggressive will cause demand destruction and will help bring inflation down to the Fed's target rate of 2%.
As of 1st of July all agriculture commodities which had a bumped up in prices have given back all its war premium and are falling fast. Back home we have CPO prices tumbling 4% yesterday trading at RM4703 and its way off the high reached on March 9 at RM7268, down a staggering 35%. Over at the Chicago Mercantile Exchange last night we saw everything from soybeans to wheat dropping over 4% in a session to close at 4 month lows. Wheat which was the biggest mover as a result of the Russia Ukraine conflict settled 30% lower from the levels reached in March at the start of the incursion.
What this means for the economy
Jerome Powell in the text of his speech has also mentioned that sparking a recession is something that the Federal Reserve aims not to do but it is increasingly difficult. So is a recession if it happens really very bad for the stock market? Actually in boom and bust cycles of the economy, recessions are very normal and is a normal course of nature to neutralizes excesses that were created during the era of easy money and also to weed out weak businesses.
The question then is how fast we get out of the recession if we get into one. The best case scenario is a V type scenario where we endure some pain but it perhaps last anything from only 6 to 12 months. The one that we want to avoid is the L shape one like the one experienced in Japan in the 1990s where the economy and stock market stayed slumped for years.
My personal view
I am of the opinion that we will enter a recession phase soon but the good news is I believe that it will be a V type of recovery as the Federal Reserve has been very proactive and made this bold move to stamp out inflation quickly. The aggressive rate will no doubt hurt many business and man on the street but it is the best way to ensure that we crimp out all the excesses and tackle the issue quickly.
Stock markets tend to be forward looking and discount most events 6 months in advance. So if one believes that we will get a V recovery, the current weakness and perhaps a bit more weakness in the weeks and months ahead may serve as a good buying opportunity. For now asset allocation and risk management are the keys for survival in these uncertain times
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