Inflation is something most active traders don’t consider much any longer. It was a huge factor for active traders in the 1970s with consumer prices spiraling upward combined with a depressed, lackluster equity market. However, with the trillions of dollars of government economic aid swirling about combined with the improving economic picture, many analysts expect inflation to return with a vengeance. Today’s active traders need to pay attention to inflation as it can potentially lead to many active trading opportunities.
Inflation is caused by the money supply increasing at a high rate. That is exactly what is happening now with the government printing presses operating at full tilt. The money supply grows faster than the speed of economic growth resulting in increased prices for the same basket of goods and services without an increase in actual value. Fortunately, inflation has been kept in check despite government cash flooding the market. As we witness the employment situation slowly improve and stock prices continue to spiral upwards, inflation will begin to be a concern. What generally occurs is the Federal Reserve uses its power to increase interest rates to slow the rapid growth thus stem inflation. Increased interest rates make it more difficult for companies to borrow money and conduct business as usual. This tightening of the money supply adversely affects the stock market by making it harder for companies to prosper. This is something that the Fed can’t avoid if it just uses the short term interest rate tool to control inflation. This adverse affect on the stock market will create many new trading opportunities on an active trader’s various trading platforms.
Prices are increasing as evidenced in January’s Import/Export figures, raw materials and consumer goods prices. This is a clear sign of pending inflationary pressures on the economy. Fortunately, the Fed has another trick in its bag, other than raising short term interest rates. Known as Quantitative Easing or QE for short, this central bank tool can help mitigate inflationary pressures. Basically it means that the Feds create money to buy government bonds and other assets. The amount is carefully controlled as to not trigger inflation yet stimulate business when interest rates are near zero. This action by the fed will likely keep the bulls in control of stocks for at least the next 6 months. However, it’s critical that active traders keep their eyes on the pending inflation signals as even the most well designed QE programs can’t keep it at bay forever.
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