The Impact of Inflation on Financial Sectors

During the MTM Monday Morning Meeting I discussed the potential impact of Wednesday’s Consumer Price Index (CPI). This price component is not the Federal Reserve’s yardstick for assessing price pressure on Americans. However, it is regarded as a prelude to the measurement the Fed favors. The inflation gauge the Fed prefers to monitor price pressure is called PCE (Personal Consumption Expenditure) Core Price Index. This report is typically released in the third or fourth week of the monthly economic schedule. The impact of inflation data has taken precedence over employment data.

The Mandate

The Fed’s mandate for monetary policy is to promote full employment and maintain price stability or stem hyperinflation. The Fed has been ultra-accommodative during the pandemic. They have kept interest rates near zero and continue to purchase bonds and agencies to pump money into the system, which increases money supply. The Federal Reserve Bank tools are used at full compacity. The Treasury is also printing money at a pace we have never seen.

The Perfect Storm

The dollar is losing value because it exists in a larger quantity. Many commodity prices are soaring. The transportation sector is lacking supply and building contractors are suffering because resource chains are disrupted. Thus, the housing market is experiencing huge markups. Lumber, copper, energy and agricultural prices are hitting extreme levels. The combination of high prices and weak currency are a tax on all of us. This phenomenon played out this week. Your dollar buys much less than it did for years. This also means stock purchases are losing value.

The Fear of Inflation

Stocks and bonds were hit hard this week, which is averse to the traditional relationship between the two sectors. Typically, bond prices rise when equities fall and vice versa. This relationship shifted this week when both treasuries and equities fell sharply. When inflation rises at an alarming rate both sectors suffer.

Option Strategies at Work

When volatility is high and price action is erratic, which is common following extraordinary moves, options are the perfect cover to ride out the storm. If implied volatility is high and daily momentum indicators shift often, utilizing credits spreads is an appropriate approach. High implied volatility coupled with confusion between bulls and bears favors trades capturing time decay. This is the current environment and credit spreads ought to pay. Bull put spreads and call calendars are best when a rally is expected following a steep correction when volatility tends to rise to uncharacteristically high levels.

Corrections and Cheap Prices

In our MTM Daily Edge sessions, we search for stocks that have cheapened at an alarming rate or reached oversold status. Then, we funnel those stocks into a group that has reached critical support areas. The combination of an oversold condition meeting solid support translates to a low risk, potentially high profit trade. The QQQ chart below illustrates this opportunity.

John Seguin, Market Taker Mentoring

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