Ouch! First quarter 2022 is going to leave a mark.  The 5th worst start to the year since 1929. 

So, what caused the pullback across the major market indices? I will say Covid because it was still hanging around. But the real culprits were the worst inflation in 40 years, rising interest rates that reflected the Federal Reserve’s realization inflation was not transitory, the industrial production shutdown across China as the communist country continued its heavy handed zero covid policy and the Russian invasion of Ukraine. I will also throw in the red flags from the bond market which have been signaling the threat of a recession.

The Federal Reserve at its March meeting raised the interest rate by .25% while continuing to print money to buy more of US government debt. The Fed is now holding approximately $9 trillion in government debt instruments or bonds.  That was a very weak response, and the inflation rate will ignore it. Fed members are now indicating a .50% rate hike at its upcoming May meeting and have outlined a plan to begin reduction of debt portfolio. Economic damage from the Russian invasion might totally stall that rate hike.  It is nice that the Fed has a year late decided that something should be done about inflation.  But the factors creating inflation might be beyond the Fed’s reach. The 1st day of the Biden administration saw the 1st shot fired in their war on fossil fuels.  Pipelines have been canceled or shut down, drilling on federal lands has been brought to a standstill and the Federal banking system has been used as a weapon to discourage lending to the fossil energy industry. The impact was immediately noticed at the gas pump and in utility bills.  But oil is also used to manufacture everything, and everything is transported to market by oil powered conveyances.  The price of everything has gone up because of decreased energy production.  Inflation has also been fueled by spiraling wage pressures which show no sign of abating.  A massive labor shortage has developed and employers are forced to shut down, shorten business hours or pay much higher salaries to continue operating.

The Federal reserve chairman, the treasury secretary and the political machine hacks all repeated the claim that inflation was transitory while looking only at the demand side of the equation.  And demand was high because the government was mailing free money to everyone.

No attention was paid to the supply chain trying to reopen after a lengthy shutdown in the Covid battle. Plenty of demand but no supply created inflation. There has been some improvement in the supply chain but not much. China in March shut down much of its industrial production in the effort to reduce Covid cases to zero. That production shutdown means store shelves will be bare in places and prices will inflate for goods that are available.

President Putin became the whipping boy for the Biden administration looking for someone to blame for inflation and shortages. One of the first acts taken to punish the Russians for invading Ukraine was the effort to restrict oil and gas sales by Russia to the US and Europe. Oil is the Russians’ best source of international income.  But also, on the Russian list of things to sale is food. Russia is the largest wheat producer in the world.  Ukraine is the fifth largest.  Together the countries are the breadbasket of north Africa and much of Europe. The gases used to manufacture computer chips and fertilizer also come from Ukraine and Russia. President Biden and other world leaders are now warning of coming food shortages and the word famine is being tossed about more and more. Food producers in the US are dealing with increased labor costs and shortages, higher energy costs, fertilizer shortages and inflationary pressures. The food price inflation over the past year could be just the beginning.

So, what’s the good news.  Hold on a second. I thought I had it here in my desk. Oh well. I’ll keep looking for it.  Meanwhile, the bond market has done most of the work in pushing up interest rates, a job normally accomplished by the Federal Reserve. Home mortgage rates have reached the 5% mark for the 30 year.  Home sales have already peaked out in parts of the country.

The bond market is flashing the warning lights that a recession in coming. The yield curve has inverted, meaning short term treasuries are paying higher interest rates than the longer term 10- and 30-year treasuries.  The inverted yield curve is not a guarantee of a recession, but in the majority of cases it is, with a recession following in the next 6 months or so. 

The announced intention of the Federal Reserve to raise rates by .50% at each of its quarterly meetings may or might not happen.  The US economy is slowing, and a monetary squeeze could trip it up. There will be shortages.

The Oak Springs investment strategy produced positive returns for the 1st quarter.  Much of that strategy will remain in place with an emphasis on commodities, energy and financials.