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How Does Inflation Affect Markets?

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JUL 18, 2022

How Does Inflation Affect Markets?

BY: FRANK KABERNA | Tastytrade

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 at their highest since 2007, and the US dollar is the strongest it’s been since early August.*

SFX / Small US Dollar Index Historical Prices



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.

S2Y / Small 2 Year US Treasury Yield Index Historical Prices


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.


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?

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Soaring Inflation has caught out the central banks. They know the key causes of inflation, primary start point is the MONEY SUPPY LEVELS, as I have discussed in my previous blogs.

ECB is in a hard place trying to juggle its southern member states mega-debts. So increasing rates as needed to control inflation (like other central banks have started to act on ), the ECB is very slow to act, afraid of this looming problem of servicing debts. They will suffer worse problems down the road and Italy will suffer a lot more , along with Germany ( the member that is financing the southern states debts indirectly via the Target2 system of the European Union members. It is similar to the old Soviet Union accounts system (among its states), and look what happened to them  -  collapsed. Similar fate for the EU down the line?

Central banks have enticed every one ( & all entities )  to borrow like mad because of "ultra cheap rates". That is the madness because rates have to go up at some point, especially having kept them so ultra low for so long. It is not natural economics. They will not be able to control the debt-implosion as they have assisted in creating the debt mountain, in attempting to "solve the economy". IT PROBABLY DOES NOT OCCUR TO THEM OR OTHERS THAT MAYBE THERE ARE OTHER KEY FACTORS THAT NEEDED TO BE SOLVED INSTEAD. WE HAVE GOTTEN INTO THE ADD-ON-LOANS, LOWER & LOWER RATES (EVEN NEGATIVE ) MEGA QE, AND LOWER AVERAGE GDP GROWTH DWINDLING ECONOMIC CYCLE. ISN'T MONETARY THEORY GREAT!!!!!!!! If you think "yes" seriously then I do not know why, when you look at all the failures using this theory, time after time, after time. Same old practices, same old "solutions" hence the same old problems delivered again.

Now we have the everything bubble period where the bubbles will burst one by one over time.

More generally, Jeremy Grantham has interesting points going forward at:


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