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How Does Inflation Affect Markets?

July 20, 2022 by Frank Kaberna| Tips & Strategies

The highest inflation measure in more than 40 years has left many markets in utter disarray: Nasdaq is at its lowest since 2020, interest rates are their highest since 2007, and the US dollar is the strongest it’s been since the early aughts.*

SFX / Small US Dollar Index Historical Prices

Source: dxFeed (https://indexit.dxfeed.com)

Though forex markets pose the largest extremes – EUR/USD lowest since 2002 and JPY/USD lowest since 1998 – inflation affects interest rates more than any other asset class.

How Inflation Affects Interest Rates and the Fed

Extreme inflation rates are some of the top market forces that the Fed and other central banks work to mitigate outside of economic recessions. Broadly speaking, central banks raise interest rates when inflation is high to contract the economy, slow the exchange of money, and reduce prices for goods and services; conversely, rates are cut when inflation is low to inspire economic growth

6E / Small 2 Year US Treasury Yield Index Historical Prices

Source: dxFeed (https://indexit.dxfeed.com)

The rise in inflation has played a significant role in US interest rates’ surge from near zero to multi-year highs; however, the Fed can only go so far in defending against its one major foe, inflation, without awakening the other, economic recession.

How Inflation Affects US Dollar and Exchange Rates

In a vacuum, rising inflation results in that region’s currency declining relative to foreign ones. In this more nuanced environment, US inflation and dollars are traveling in the same direction as the former creates fear and the latter acts as a flight-to-quality asset.

Interest Rate Benchmarks from International Central Banks

United States 1.63%
Eurozone 0.00%
England 1.25%
Japan -0.10%

Source: Yahoo! Finance (https://finance.yahoo.com)

Currencies are a game of relativity, so some currencies must perform positively even in an inflationary period. Since the United States is at the forefront of hiking interest rates in an effort to combat inflation, its relatively higher rates are translating to higher USD prices. (Relative interest rate values between two regions commonly translate directly to their relative exchange rate performance – higher rates means appreciating currency.)

How Inflation Affects the Stock Market

This leaves the stock market in an even more opaque position. While high inflation can mean higher interest rates that contract the economy moving equity valuations lower, at some point the stock market might slide enough to constitute an economic recession warranting lower interest rates. Such is the balancing act that faces the Fed ahead of what could be the most important rate decisions in decades.

Traders have a balancing act of their own to deal with as stock, bond, and forex markets all pose historical extremes: do you go with or against it?

 

*All values in this article taken 7/14/22 Sources: US Bureau of Labor Statistics (https://bls.gov) and Yahoo! Finance (https://finance.yahoo.com)

—

To learn more about how the Small Exchange is merging the efficiency of futures with the clarity of stocks, make sure to subscribe to their YouTube channel and follow them on Twitter so you never miss an update.

© 2022 Small Exchange, Inc. All rights reserved. Small Exchange, Inc. is a Designated Contract Market registered with the U.S. Commodity Futures Trading Commission. The information in this advertisement is current as of the date noted, is for informational purposes only, not intended as a recommendation, and does not contend to address the financial objectives, situation, or specific needs of any individual investor.  The information presented here is for illustrative purposes only and is not intended to serve as investment advice since the availability and effectiveness of any strategy is dependent upon your individual facts and circumstances. Trading in derivatives and other financial instruments involves risk.

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Filed Under: Tips & Strategies

About Frank Kaberna

Frank Kaberna is the head content strategist at the Small Exchange. He produces everything from brochures to videos that inform on the Small Exchange’s products. After earning a mathematics degree from the University of Michigan, Frank traded interest rates at the Chicago Board of Trade. He then worked on the tastytrade Network as a content producer and on-air talent before landing at the Small Exchange.

Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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Risk Disclosure

The StoneX Group Inc. group of companies provides financial services worldwide through its subsidiaries, including physical commodities, securities, exchange-traded and over-the-counter derivatives, risk management, global payments and foreign exchange products in accordance with applicable law in the jurisdictions where services are provided. References to over-the-counter (“OTC”) products or swaps are made on behalf of StoneX Markets LLC (“SXM”), a member of the National Futures Association (“NFA”) and provisionally registered with the U.S. Commodity Futures Trading Commission (“CFTC”) as a swap dealer. SXM’s products are designed only for individuals or firms who qualify under CFTC rules as an ‘Eligible Contract Participant’ (“ECP”) and who have been accepted as customers of SXM. StoneX Financial Inc. (“SFI”) is a member of FINRA/NFA/SIPC and registered with the MSRB. SFI does business as Daniels Trading/Top Third/Futures Online. SFI is registered with the U.S. Securities and Exchange Commission (“SEC”) as a Broker-Dealer and with the CFTC as a Futures Commission Merchant and Commodity Trading Adviser. References to securities trading are made on behalf of the BD Division of SFI and are intended only for an audience of institutional clients as defined by FINRA Rule 4512(c). References to exchange-traded futures and options are made on behalf of the FCM Division of SFI.

Trading swaps and over-the-counter derivatives, exchange-traded derivatives and options and securities involves substantial risk and is not suitable for all investors. The information herein is not a recommendation to trade nor investment research or an offer to buy or sell any derivative or security. It does not take into account your particular investment objectives, financial situation or needs and does not create a binding obligation on any of the StoneX group of companies to enter into any transaction with you. You are advised to perform an independent investigation of any transaction to determine whether any transaction is suitable for you. No part of this material may be copied, photocopied or duplicated in any form by any means or redistributed without the prior written consent of StoneX Group Inc.

© 2023 StoneX Group Inc. All Rights Reserved

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