Inflation Soars to 3.3%

The recent CPI report showed an unexpected and significant increase in the inflation rate, climbing from 2.4% to 3.3% in a single month. This surge is attributed to rising energy prices, particularly due to the situation in Iran, highlighting how rapidly economic conditions can change. This development brings the Federal Reserve closer to a "checkmate" scenario, a situation previously discussed where the Fed becomes unable to cut interest rates despite a weakening economy. This predicament arises from rising energy prices driven by supply constraints in a late-stage business cycle. The Fed's dual mandate of maximum employment and price stability is challenged when both unemployment and inflation rise simultaneously. The current inability to address both issues is the core of this dilemma. While not yet in full checkmate, the economy is heading in that direction. The labor market has shown resilience, preventing a more immediate crisis, but underlying weaknesses are becoming apparent. The inflation rate currently stands at 3.3%. Examining specific categories within the CPI report, food and beverage inflation remains moderate, and housing inflation continues its downward trend, which constitutes a significant portion of the CPI. The rise in overall CPI despite moderating housing costs indicates substantial increases in other sectors, notably apparel and transportation. Medical care costs are still elevated, while recreation, education, and communication expenses are lower. The market's expectations for the Fed's actions have drastically shifted. Previously, markets anticipated multiple rate cuts in 2026. Now, it's evident that the market, through indicators like the two-year yield, signals the Fed's inability to cut rates. Currently, there's a 98% chance the Fed will hold rates steady in late April. Furthermore, there's a greater than 90% probability that the Fed will not lower rates until October of this year, with nearly a 90% chance even then. The Bank of Japan may also consider raising rates soon. This energy-driven inflation is preventing the Fed from lowering interest rates, which is problematic given the weakening labor market. The labor market's current stability, evidenced by a relatively unchanged unemployment rate over the past six months, is the primary reason why the situation isn't a full checkmate yet. However, other indicators point to significant underlying weakness. Hiring has plummeted, and job openings have decreased substantially. Layoffs, while not yet materializing significantly, are expected to follow as lower asset prices typically precede them. Although Bitcoin has declined, the stock market has remained relatively strong, not yet reaching levels that would trigger a widespread layoff cycle. The possibility of the S&P 500 reaching new all-time highs cannot be ruled out. Historical patterns, such as those seen in 2022, show impressive stock market rallies following initial drops, which ultimately led to lower highs. The speaker emphasizes the importance of being aware of a potential "sweep" of prior all-time highs, where the market rallies to new peaks, encouraging FOMO (fear of missing out), before a recession begins. This pattern was observed in the dot-com era. Comparing the S&P 500 divided by the money supply to historical data, the current business cycle appears to be mirroring the 1996-2000 period. Similar drops and subsequent rallies have occurred, leading to a final rally and then the onset of a recession. However, when examining the S&P 500 divided by gold, current valuations are more akin to 1973 and 2008. The S&P 500's valuation relative to gold is significantly lower today (1.4 times) compared to the year 2000 (5.5 times). This suggests that a direct replication of the 2000 scenario might not occur. Nevertheless, the pattern of the stock market breaking down against gold has historically coincided with stock market tops in 1973 and 2007-2008. The underlying weakness in the labor market, though not yet evident due to subdued layoffs, is a critical factor. When layoffs eventually pick up, the lack of hiring will cause the unemployment rate to rise non-linearly, signaling the end of the business cycle. This is consistent with the ITC business cycle metric, which indicates a late-stage environment. Inflation rising in a late-stage economy due to supply-side issues, rather than demand, further supports this outlook. Additionally, the elevated liquidity risk metric reinforces the assessment of a late-stage business cycle. If inflation continues to rise, it will lead to the Fed's checkmate, signaling the end of the business cycle and potentially a crisis. The process can be prolonged, with 2026 potentially characterized by the Fed's inability to cut rates, leading to lower prices in riskier assets like altcoins and Bitcoin, with the stock market likely to follow. The topping process for the stock market is extended, similar to Bitcoin's trajectory, involving initial highs, drops, and subsequent rallies to retest previous peaks before a significant downturn. The speaker suggests that a lower high in the stock market would be a more favorable outcome for a prolonged secular bull market, whereas a higher high could be more bearish. The current situation is characterized by "checks" leading towards checkmate, and it's important not to be overly deterministic about the market's immediate movements. While the stock market faces headwinds, opportunities for profit exist in other sectors like energy, manufacturing, metals, and international funds, even during crypto bear markets. The Fed may ultimately be too late to rescue the labor market. However, aggressive rate cuts now would likely reignite inflation. The Fed's current inaction, while understandable, might lead to a delayed response that proves insufficient to prevent a non-linear rise in unemployment. This scenario is projected to unfold over the next one to two years. Awareness of both the broader business cycle and its internal fluctuations is advised.