The impact of inflation on stocks
Last week the US released its latest inflation figures, which over the past three months has been increasing significantly to levels known as "hyperinflation". Inflation has been a major issue for the US economy and for the Central Regulators who seem to not know exactly how to approach the issue while employment remains low. As part of the article we shall look at what hyperinflation is and what it means for the US stock market.
This year after the financial stimulus which was introduced by the new government, economists predicted high levels of inflation due to the pump of cash into the economy. The Federal Reserve also commented on this advising high inflation is likely, but may not be here in the longer term and therefore, no current need for altering the monetary policy while unemployment remains high. Now that inflation has reached over 5%, mainly due to the rise in energy prices, traders have been evaluating what the market reaction is likely to be. It is not only the US Dollar which is likely to be affected, but also stocks. Last week, we saw quite a large rise in the US Stock Market after the announcement of a 5% inflation. After the announcement the SNP500 grew by 0.65% within two hours, the Dow Jones by up to 0.72% and the Nasdaq by 1.53%. Overall the biggest winner for the day was the Nasdaq followed by the Dow Jones.
When we see high levels of inflation, a common side effect is the devaluation or lowered purchasing power within the economy. This alone means that stock can become harder to purchase, especially by individuals within the country. Subsequently, this can increase the demand amongst foreign buyers as foreign currency may be able to benefit from a more competitive exchange rate. In addition to this, normally when a market sees hyperinflation the central banks look at different possible methods of controlling the rise in prices. One method is by increasing the federal funds rate, the Federal Reserve is effectively attempting to shrink the supply of money available for making purchases. At the same time this also makes other investments, such as savings accounts and fixed deposits, more attractive due to the increase in the investment yield.
Furthermore, an increase in interest rates can alter investors spending and investing habits due to the cost of living. Individual investors are impacted through increases to their credit card, overdrafts and mortgage interest rates, especially if these loans carry a variable interest rate and have not been fixed for the longer term. When the interest rate for credit cards and mortgages increases, the
amount of money that consumers can spend decreases. As a result of this, certain groups may avoid investing, or generally spending extra capital. This will not only affect the direct demand of the stock market, but also the sales figures and company revenues.
It is important to note that correlations should be considered when analysing the market, whether the currency exchange market or the stock market. It should be noted that correlations are not always as strong and can have different effects depending on the market overall, for example the market at the moment is witnessing very high unemployment, lockdowns and economic restrictions, all are aspects of the market we have not previously witnessed. For this reason, it is also important to evaluate the overall stock market conditions and sentiment. This can be done through analysing not only individual stocks, but indices such as the SNP500, NASDAQ and Dow Jones.
This article was written and submitted by eXcentral.
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