Frances Newton Stacy, Director of Strategy at Optimal Capital, breaks down how skyrocketing commodity prices are impacting markets and what the Fed should be doing in order to avoid stagflation. 

Opening Bell

Market Sell-off Continues as Investors Are Concerned That Russia-Ukraine War Could Slow Economy

but for some more insight in early morning trading, I'm joined by Frances, Newton Stacy Director of strategy at optimal capital Francis. Just want to get your first read on what I said there a moment ago, the dow earlier this morning was looking to open just in kind of a bit of a freefall. 500 points lower. It has since come off of that now about 100 and 32 points lower. The same kind of consideration for the S. And P. And even the NASDAQ here. What's your take on kind of this early morning activity and volatility we're seeing. Well, I think so much of the bad news is priced in in the interim. I think that you know, the Ukraine situation is lasting a lot longer than we had maybe anticipated and probably will carry on for a while. So the markets are trying to digest that I think that we of course have the Fed meeting next week. And I think that the markets are expecting per jay, Powell's testimony a quarter point hike in the March meeting. I think they've taken the 50 basis point hike off of the table. And so as we see markets start to price things in, we should see some stabilization in the short term. Um looking for the NASDAQ to hold 13 1 25 which would be a higher low from february 24th. Looking for the S and P 500 to hold 40 to 77 again a higher low from february 24th. Princess you were just noting this, We were just noting this a moment ago before the break we were talking and obviously oil prices, we know the U. S. And european leaders are looking at kind of banning or a ban on Russian oil congress here. This kind of a bipartisan effort to see that happen. We don't know how successful will end up being but there is that growing momentum there. How could this kind of impact the global oil market and the gas industry? Especially with the pandemic? I mean largely behind us. What's your outlook overall on the energy market? Um you know, for the last three months and and even kind of moving forward here? Well I think oil is going to continue higher until there's some sort of a resolution that scene. I mean there is some more production coming on. Um but it's just kind of a slow reaction right now. It's very new sensitive is understandable. I'm not a Russian and Ukrainian geopolitical specialist by any means, but of course we're looking for, you know, technical levels for oil to hold, most notably though just going forward as far as pricing this in from the market's perspective is the fact that you know, a spike in oil, whether dramatic or you know slow has really caused recessions, you know, most of the time um and has preceded recessions and that's because The spikes in oil eventually create demand destruction. I heard some analysts this morning talking about 450 as a gas price of course not including New York and California but 450 is really kind of a breaking point when consumers start to change their behavior with the transitory narrative around inflation which is of course never mentioned now. Um We see that you know maybe people didn't sell their gas guzzling SUVs, maybe they didn't change their behavior, maybe they didn't change their travel. There was a lot of liquidity in the system, a lot of spending power as we see liquidity system being drained through the tightening cycle as we see spending power going down as we see persistently higher energy prices. You're going to start to see some demand destruction that's going to affect real growth. What is your level of concern? And I was gonna ask about a recession but you kinda clearly indicated there is obviously that level of concern to some extent there but the level of concern around stagflation, if we have oil prices that get up to you know $150 a barrel which are just numbers you wouldn't have thought about three or four months ago. But now numbers that people are throwing out there as real realities right? We could see $6 a gallon in some cases that's obviously to your point a moment ago gonna affect consumer spending and then we'll get AC. P. I read tomorrow to see if inflation is still just hotter than expected or continuously hotter than expected? All of that in in totality. What's the level of concern around something like a stagflation because that word is now being thrown around more. Yeah, so I was sort of in before the Ukrainian situation, I was sort of in the camp that um you know, we were gonna see peak inflation. Now let's look at the mechanics of inflation. The mechanics of inflation are, it's the ratio of money to goods in the system, right? So if you have a higher ratio of money to goods, more money is going to be allocated to those goods meaning prices are gonna go up. That's the very basic scenario. So now the Fed is lowering the ratio of money in the system and there is a lag effect without the Ukrainian situation, we would have probably seen a peak and inflation sooner the markets will start to price that in as tightening gets more aggressive. Most interesting thing is reading one of our data providers last week is if you really look at the net effect through the shadow Fed funds rate of the quantitative easing being removed from the system, you really can bake in uh that we've already had about six quarter point hikes in the system and then you sort of add the rest of the, you know asset purchases disappearing at the end of this week and then you add the quarter point next week and you're looking really at about an eight or a nine, you know the effects on the money supply which is based in the mechanics of inflation of like you know nine quarter point hikes. Okay last cycle when we had the reversal in 2018 markets sold off 20% Jwpowell pivoted, you still had a liquidity shortage in the overnight market in september of 2019 when they tried to get those corporate tax payments. You know they settled, they tried to get sales to settle to pay those corporate tax payments. You still have that problem. Powell is going to be more and more and more increasingly frustratingly conservative despite the C. P. I. Print on thursday because again you're also seeing a divergence from you know the headline CPI I number and what we think is coming for the core number and the Fed doggedly follows the core number whereas the White House is being held accountable to the C. P. I. Number and they're starting to be a bit of a divergence in those numbers. So I expect that the markets now are going to look in the short term to you know potentially holding these higher lows which I mentioned earlier um around the fact that a lot of this is being priced in but if we put nine rate hikes into the system and then we think they're going to be more rate hikes, those liquidity ratios will adjust and we will go from a stagflation eri environment which is created by these further supply chain disruption and upset with the geopolitical scene into something that's very unsustainable because of the demand destruction and that will start to weigh on inflationary pressures latter half of the year we see more risk for deflation. You know, I've always a kid, kind of the Fed's decision. Um, and next steps to be something like obviously, you know, needing threading a really fine needle, but now it really seems um kind of, you know, much greater, maybe, perhaps kind of taking a step and not trying to, you know, step on a landmine where things blow up and we get into a stagflation environment where you get to a a recessionary environment, You know, we talk about oil right? Because that's kind of the most consumer facing side of things. And it's certainly kind of a big part of the inflationary picture, but commodities, I mean, let's go there for a second week is at a record high and China is saying that they want to reduce its dependence on grain imports and increase kind of its soybean soybean production into 2025. What's your take on the overall commodity, the space and what should us investors right now be paying attention to? Well, commodities are going to be lagging to what the Fed is actually doing. And that's what the Fed understands. So the Fed is already tightened quite a bit really if you look at the shadow, uh, Fed funds. Um, the fact the Shadow Fed funds rate. But the thing is, is that these tightening effects have lagged, so they go through the system. So as we start to see this, as commodities start rising as we get, you know, sort of a destruction and consumer spending ability and savings that are going away and, you know, markets are declining and people are losing money. Um, you are just going to see, you know, some demand destruction eventually, that what's the answer to higher prices, higher prices. Uh, let's just talk aluminum, nickel and other commodities there at kind of nearly 10 year highs, I think of automakers like Tesla GM, and still Lantus. Um, they're concerned over these rising, rising commodity prices and their ability to kind of make chips and other parts. Should investors be that concerned? Um, you know, at this commodity shock that could lead to, I hate saying it. Another supply chain kind of disruption. That's the risk. Um, really, you know, we've seen some progress in the supply chains and now that, you know, this puts the conversation on the table, that we could see another supply chain disruption that could keep elevated prices for a while and what that does to the consumer. It's, it remains to be seen. Um, again, going out towards the second half of the year, I think deflation is more of a risk than stagflation. We'll just have to wait and see how the rate of change occurs. Um, you know, with the month, over month numbers. Um, and so we'll just kind of watch that. But I think that deflation, given the fact that the money supply is, you know, being reduced at a rapid rate at this point, we're no longer going to be adding anything to the balance sheet. And remember that, you know, the money supply is always draining because anytime you service debt, that's taking money out of circulation, at least the principal amount. So The thing is that's always draining and now we're not adding to it anymore. So if you give your teenager $10,000 a month and don't do that, it's not a good idea. But if you give your teenager $10,000 a month and then you start giving him nothing. It is going to change his lifestyle eventually. So when we look at things on a smaller scale than all of the moving machinations of the global macro situation, it's very easy to see that when you stop adding that much money to the system, Um, as we were, you know, at the height, adding 120 billion a month, it's going to change the dynamics pretty drastically. As far as how long commodities will be elevated, you know, remains to be seen. The crystal ball is not working this morning. No, it never is right. This is a constant game of wait and see kind of waiting and seeing what gets added to the equation as it continues to change every day as always, thank you so much for your insight Frances Newton Stacy, director of strategy at optimal capital.