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Effects Of Inflation On The Capital Markets

Summary of Article entitled:  “Effects of Inflation on the Capital Markets”  by James A Kyprios and Craig Wolson (Read full-length article here)

Consumer price inflation is back after 40 years.   Those familiar with the previous inflation cycle in the late 1970s and early 1980s know how hard it can be to get rid of inflation and inflationary expectations.  Consumer price inflation is felt at the gas pump and at the grocery store and is especially damaging to the poor and those on fixed-income pensions.  As shown by the legendary Central Bank Chairman Paul Volker, inflation can be conquered by drastic monetary tightening, which increases interest rates and very often causes serious recessions.  

Less commonly understood is the fact that there has been an asset inflation (stocks and real estate, for example) over the last 40 years, as interest rates have steadily decreased during this period.  In recent years, rates have reached record low levels.  The era of “free money” came into being and caused a massive debt bubble.  We have in recent years become accustomed to virtually no interest earned on savings accounts and very low rates on even riskier investments such as junk bonds.  We have become used to a soaring stock market. 

 Why has consumer price inflation come back? Directly and indirectly, the inflation is the result of Covid, which caused supply chain difficulties, and more recently the war in the Ukraine, which upended the energy markets. 

When consumer price inflation reared its ugly head last year, the Fed drastically increased interest rates. The Fed funds rate (the short-term rate that domestic banks use to borrow from each other) has increased from about ¼ of 1% to close to 4.5% in 2022.  The Fed is convinced that it needs to tighten further in order to make sure that inflation once again returns to the Fed’s target of less than 2% per annum. 

Tightening of credit has already had a pronounced effect on the stock market.  Now that rates are much higher and still rising, the dangers of a debt bubble are becoming obvious.  There are a significant number of companies that will no longer earn enough money to pay interest.  There will be more downgrades, more bankruptcies and much more difficulty in obtaining financing.  All this will in turn lead to more litigation.

The days of free money are now over.   For many companies and investors, this new world will not be pretty. 
(Read the full-length article here)

James A Kyprios
Kyprios International Services

Cell:    917-613-4508
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Rye Brook, NY 10573

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