Our Commentary
German PPI
German PPI, a measure of prices paid by producers of goods and services, was up a stunning 45.8% over last year in August and 7.9% over the prior month. Unsurprisingly, the bulk of the increase was due to a dramatic rise in energy prices, up 139% over last year and 20.4% from the prior month. While the surge in European energy costs is widely known, it is still striking how much the latest reading of inflation in Europe’s largest economy exceeded expectations. Even taking energy out of the equation, PPI was up 14% over last year. We believe this means the European Central Bank will have to remain aggressive in raising interest rates.
Russian escalation
Russian President Putin announced a further mobilization of the Russian population by drafting an additional 300,000 available reservists into the military (with a total of up to 1mm). Putin also reminded the world that Russia has a vast nuclear arms stockpile and would not be afraid to use them. In addition, Russia announced referendums in currently occupied parts of Ukraine, letting people vote on the prospect of joining Russia. These recent developments put to rest any hopes of an impending resolution to the war. Markets dislike uncertainty, and unfortunately, this situation remains uncertain for the foreseeable future.
Is TINA over?
Since the financial crisis over a decade ago, a common explanation for the continued rise in risk assets (stocks, real estate, etc) has been that “There Is No Alternative” (TINA). As the Federal Reserve has kept interest rates at historically low levels, there has been no other place to earn a respectable return but in risk assets. As interest rates have reverted to levels not seen in some cases for decades, there is yet again an alternative. Given the very low-interest rate environment over the past 15 years, savers who typically invest in bonds have been forced into risker assets to generate returns. With the latest 75 bps rate hike this week, for the first time since before the financial crisis, we are finally starting to see value in short-dated US treasuries, where yields have spiked north of 4%.
The US dollar juggernaut
The US dollar (USD) has risen more than 16% versus a basket of currencies since the beginning of the year, a HUGE move. Some of this can be attributed to the Federal Reserve’s interest rate increases, which have been somewhat ahead of other countries. In addition, the USD is the global reserve currency and has benefited from its value in a geopolitically uncertain world. A strong USD has many downstream ramifications. US-based multinational companies doing business abroad will find their Non-USD profits are worth less when repatriated back to the US. A strong USD also helps curb domestic inflation while flaring inflation abroad.
While the USD has been very strong against almost all currencies, it has been particularly strong versus currencies of countries that have been stubborn in raising interest rates, such as Japan. The Japanese Yen has fallen ~30% against the USD since the beginning of this year, to a level not seen in 25 years. The steep decline finally forced the Bank of Japan to intervene to prop up the Yen's value for the first time since 1998.
