The Broken Fed

Brit Ryle

Posted June 22, 2023

We talked on Friday that it was time to take a little off the table. After all, the S&P had shot 3.6% higher since a new bull market was confirmed on June 8. 

And right on cue, the selling started. The S&P 500 has been down every day since Friday.

Yes, the pullback we’ve seen is partly because the AI hype was off the charts. And the rush to buy stocks after the “surprise” breakout for stocks at new highs had a roll to play too…

I say “surprise” because it sure seemed like the investment bank strategists and financial media talking heads switched from bearish to bullish overnight. 

But the biggest surprise — the shift in thinking that’s most responsible for the recent weakness — is what Fed chair Jerome Powell said about interest rates last week…

If you missed it — which would’ve been difficult, given the amount of news coverage his comments got — Powell basically said the fight against inflation isn’t done and there are more rate hikes coming.

Now, I have been pretty adamant that the Fed wasn’t going to hike at the June FOMC last week, that a pause was in order. Inflation has been trending lower for months now. And the shift in investor sentiment as they recognized that inflation trend absolutely helped stocks make the recent bull market breakout…

I’ve also been pretty adamant that last weeks rate hike pause would prove to be more than a pause, that the Fed was done with rate hikes this year…

So Chair Powell’s insistence that the Fed isn’t done and that we may get even two more hikes this year came as a surprise. And not just to me. The whole market was taken aback by the forcefulness of Powell’s promise to take rates higher. 

Is Powell “Jawboning?”

Now, it is absolutely possible, even likely, that Powell’s thought talk is jawboning. That Powell is using his words to keep the bond and stock markets on their toes. Because markets are always forward-looking, investors and traders price in expectations for the future. They will “buy the rumor” and price assets and make business decisions as if rates will indeed head higher still…

Now, Chair Powell has spent the last couple of days giving his semi-annual testimony before Congress. And of course, Congress likes to grill the Fed about its failures…

And so Congress has spent most of its time with Powell to dissect exactly how it was possible that the Fed could’ve missed the glaring liquidity problems at regional banks that led to the failure of Silicon Valley and First Republic banks and required massive actions by the Fed and Treasury to backstop the banking system.

And rightfully so. Because the Fed’s failure to properly regulate banks is a pretty egregious dereliction of duty. 

But it’s not the Fed’s biggest failure…

The True Nature of Inflation

Back on March 29, I wrote: 


With 20% market share, Cal-Maine (NASDAQ: CALM) is the biggest egg-seller in the U.S. The company made a lot of money over the last few months. 

According to its Q1 earnings report that came out this morning, total revenue for the quarter was up 108%, to $997 million. But net profits? Holy moly…Cal-Maine reported net income of $39.5 in the same quarter last year. This year, reported net income was $323 million!!

That’s not a typo – Cal-Maine saw a nearly 10-fold jump in profits from a year ago. 

Now I can’t tell you that Cal-Maine hatched some evil Montgomery Burns-style plot to gouge consumers, but it seems pretty clear that Cal-Maine did more than just pass its own higher costs off on consumers…

And we got more confirmation of corporate price gouging a month later. On April 28, I wrote:

“[In its first quarter earnings report] Pepsi’s Frito-lay division reported a 16% gain in revenue even though sales volume was flat from the year before. It would be interesting if I could tell you that the revenue gain came from some startling Artificial Intelligence application that boosted margins for Dorito’s.  

But there was another kind of AI at work – artificial inflation. 

And it wasn’t just the Frito-lay division that benefited from higher selling prices. The North American beverage segment grew revenue by 12%, even though sales volumes actually fell 2%. And the Quaker Foods segment showed 10% revenue growth while Quaker beverages were flat and Quaker convenient foods sales volumes fell 5%. 

The implication is pretty obvious. Pepsi has implemented price hikes of around 15% across the board, and those price hikes have had a minimal effect on sales volumes – a casualty rate that falls well within “acceptable” parameters…

 It’s pretty obvious what’s going on here. For Pepsi, “inflation” simply means the price hikes they’ve made on the products they sell. So when the CEO says “deceleration of inflation,” he simply means that Pepsi won’t be hiking prices much anymore. And in fact, he says that outright – “…the majority of our pricing is already done.”

The funny thing about price hikes like these is that we consumers typically accept them on the understanding that since the company has higher costs, they pass some or all of those costs off on us. It’s like conventional wisdom. 

But the thing is – Pepsi actually saw its gross margins get better during the first quarter. Which tells us that regardless of how much its own costs rose, it raised selling prices a whole lot more…

Artificial Inflation indeed…”

We heard the same thing from Proctor & Gamble (NYSE: PG), Coca-Cola (NYSE: KO) and Hershey (NYSE: HSY). Yes, costs were a bit higher. But profits surged because companies raised prices much more than their costs. 

So the question is: what is the Fed supposed to do about inflation that is being driven by corporations hiking prices much more than their costs warrant? 

Well, there’s only one thing the Fed can do: raise interest rates to dampen demand by getting people fired. In other words, the Fed’s only choice means punishing American workers to offset corporate greed. 

The Fed’s ability to fight the true nature of inflation is broken. Regular Americans are paying the price while the real culprits get a pass. 

Maybe that’s something that Congress should take a look at. But of course, they’re all bought and for anyway, so I guess we’re on our own.

That’s it for me today. Take care and I’ll talk to you tomorrow…

Briton Ryle
Chief Investment Strategist
Pro Trader Today